ASSESSMENT OF WORKING CAPITAL

Any enterprise whether industrial, trading or other acquires two types of assets to run its
business as has already been emphasised time and again. It requires fixed assets which
are necessary for carrying on the production/business such as land and buildings, plant
and machinery, furniture and fixtures etc. For a going concern these assets are of
permanent nature and are not to be sold. The other types of assets required for day to day
working of a unit are known as current assets which are floating in nature and keep
changing during the course of business. It is these current assets which are generally
referred to as working capital. !e are by now already aware of the short "term nature of
these assets which are classified as current assets. It may be noted here that there may not
be any fixed ratio between the fixed assets and floating assets for different pro#ects as
their requirement would differ depending upon the nature of pro#ect. $ig industrial
pro#ects may require substantial in%estment in fixed assets and also large in%estment for
working capital. The trading units may not require hea%y in%estment in fixed assets while
they may be carrying huge stocks in trade. The ser%ice units may hardly require any
working capital and all in%estment may be blocked in creation of fixed assets.

A set financing pattern is e%ol%ed to meet the requirement of a unit for acquisition of
fixed assets and current assets. Fixed assets are to be financed by owned funds and
long"term liabilities raised by a unit while current assets are partly financed by long"term
liabilities and partly by current liabilities and other short"term loans arranged by the unit
from the bank. The balance sheet of a unit under such dispensation may be represented as
in next page.
The total current assets with the firm may be taken as gross working capital whereas the
net working capital with the unit may be calculated as under&

'et !orking (apital ) (urrent Assets " (urrent *iabilities
+'!(, +-!(, +including bank borrowings,

This net working capital is also sometimes referred to as liquid surplus with the firm and
has been margin a%ailable for working capital requirements of the unit. Financing of
working capital has been the exclusi%e domain of commercial banks while they also grant
term loans for creation of fixed assets either on their own or in consortium with .tate
le%el/All India financial institutions. The financial institutions are also now considering
sanction of working capital loans.

The current assets in the example gi%en in the earlier paragraph are financed asunder&

(urrent Assets ) (urrent liabilities / !orking capital limits from banks / 0argin
from long"term liabilities
*iabilities

Assets
(apital



Fixed Assets

*ong"term
liabilities

0argin '!(
*iquid .urplus



!orking capital
limits from
banks

(urrent *iabilities

c urrent Assets

+1iagram 2,

This is the normal pattern of financing of current assets. 3owe%er, a few units may be
ha%ing a negati%e net working capital as shown below &


*iabilities



Assets

(apital



*ong"term
*iabilities


Fixed Assets


Working capital
deficit




(urrent
*iabilities


(urrent
Assets


The assessment of working capital may in%ol%e two aspects as under
4 The le%el of current assets required to be held by any unit which is adequate for
its day to day functioning, and
4 The mode of financing of these current assets.
CONCEPT OF MARGIN

0argin in relation to working capital has two concepts which need to be clearly
understood. The one concept of pro%iding margin by way of liquid surplus i.e. from
long"term liabilities has already been explained. It must be clear by now that current
assets shall partly be financed by capital 5 long"term liabilities for any going concern.
This gains importance while fixing o%erall limits of working capital by the bank.

The other concept of margin as applicable to working capital limits is related to the %alue
of security charged to the bank as co%er for these limits. Financial accommodation up to
2667 of the %alue of goods would not be granted by the banks and they would fix a
certain margin on the %alue of security which must be pro%ided by the borrower and the
balance amount will be financed by the bank. The percentage of margin fixed on any
security is dependent on its nature.

FORMAT FOR ASSESSMENT OF WORKING CAPITAL

In good old days when the banks were mainly adopting security"oriented approach in
lending, no emphasis whatsoe%er was placed on assessment of limits as the credit
decision was mainly based on the security a%ailable to co%er the ad%ance. The concept of
assessment of working capital gained currency in early se%enties and 8eser%e $ank of
India proposed a scientific method for this purpose. A format that would be utilised for
assessment of working capital was also prescribed. 9arious other formats and techniques
for assessment ha%e since been de%eloped for different kinds of pro#ects, the earlier
format ne%ertheless is still in %ogue and is made use of in all such cases where a specific
method has not been prescribed. The proforma as prescribed by 8eser%e $ank of India is
reproduced below &

Ae!ent of Working Capital Re"#ire!ent

$$$% months raw material requirements
8s.
$$$% !eeks:/months consumable stores and spares
8s.
$$$% !eeks: stocks in process at any one time
8s.
+a%erage period of processing %alue of raw material
content in stock"in process and manufacturing expenses
for the period of processing to be indicated,
$$$% 0onths: finished goods at cost
8s.
$$$% !eeks:/months: recei%ables representing credit sales
8s.
;ne months manufacturing and administrati%e expenses
8s.
<<<<<<<<<<<<<<<<

Total working capital requirement
*ess (redit a%ailable on purchases and ad%ance payments recei%ed .
8s.
!orking capital in business or liquid surplus
8s.
<<<<<<<<<<<<<<<<
'et working capital requirements
8s. +A,
<<<<<<<<<<<<<<<<
=ermissible *imits
8aw materials 8s.
*ess 0argin 8s.
8s.
.tock"in"process 8s.
*ess 0argin 8s.
8s.
Finished goods 8s.
*ess& 0argin 8s.
8s.
8ecei%ables representing supplies to -o%t. 8s.
*ess 0argin 8s.
8s.
8ecei%ables representing supplies to sundry parties 8s.
*ess 0argin 8s.
8s.
<<<<<<<<<<<<<<<<<
Total limits
8s. +$,
<<<<<<<<<<<<<<<<<<

'et working capital requirements +A,
8s.
=ermissible limits +$,
8s.
1eficit, if any +A"$,
8s.

!e shall now make an attempt to define %arious components of working capital as taken
in the format and explain the most acceptable principles in%ol%ed in calculating them for
o%erall assessment of working capital.

I % $$$$$$$% months: raw material requirements &

>%ery production unit will be required to maintain a minimum le%el of raw material in
stock to ensure continuous production. The le%el of stock may differ from unit to unit and
inter alia depends on nature of the raw material, its a%ailability with particular emphasis
on lead time in%ol%ed in procuring it, price le%el, consumption pattern etc. From the past
records, it is possible to find out the a%erage stocking period of raw material with the
following formula &

A%erage stocking period in months ) A%erage stock of raw material
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
A%erage monthly consumption of raw material
during the year

where


A%erage stock of raw material ) ;pening stock of raw material/ (losing stock of
raw material
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
?
A%erage monthly consumption of
raw material during the year ) ;pening stock of raw material / Total purchases
of raw material" (losing stock of raw
material of raw material
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
2?

The a%erage stocking period thus arri%ed may be taken as the requirement of so many
months of raw material for the unit and the estimated %alue of stocking of raw material
required by the unit can thus be determined on the basis of pro#ected figures.

In case of new units where figures of past performance are not a%ailable, storage period
may ha%e to be compared with storage period of such other units for the purpose of these
calculations.

II $$$$$$$$$$% weeks/months: stores and spares

The calculation for requirement of these items may be done in a similar manner as in case
of raw materials. The a%erage period of stocking required by the unit is generally, done
on the basis of past performance. After determining the a%erage period, the requirement
is to be calculated on the basis of pro#ected figures

III $$$$$$$$$$ weeks: stocks in process

.tocks"in"process is an item representing goods remaining in semi"finished form awaiting
certain further processing before these can be finally con%erted to finished goods. The
requirement of blockage of funds in these stocks will depend upon the processing period
in%ol%ed in the manufacturing. The processing period may differ from unit to unit and in
case of new units it may ha%e to be compared with existing units of similar nature.

.emi finished goods, howe%er, possess another problem in e%aluation. The %alue
representing manufacturing expenses is added to the cost of raw material to determine the
%alue of stocks in process. The %alue of stocks"in"process is thus related to the cost of
production: which may be calculated as under &

Cot of Prod#ction

+i, 8aw material consumed
8s.
+ii, ;ther spares
8s.
+iii, =ower and fuel
8s.
+i%, !ages
8s.
+%, 8epairs and maintenance
8s.
+%i, ;ther manufacturing expenses
8s.
+%ii, 1epreciation
8s.
+%iii, .ub"total
8s.
@items +i, to items +%ii,A
+ix, Add & ;pening stocks in process
8s.
+x, .ub"total @item +%iii, plus item +ix,A
8s.
+xi, 1educt & (losing stocks in process
8s.
+xii, (ost of =roduction @item +x, minus item +xi,A
8s.


The a%erage period of stocking of stocks in process may nom calculated with the
following formula &

A%erage period of stocking of ) A%erage stock in process
stocks in process in days <<<<<<<<<<<<<<<<<<<<<<<<<<<<<
1aily cost of production

where

A%erage stock in process) ;pening stock in process / (losing stock in process
?

1aily cost of production ) (ost of production
BCD

A%erage stocking period which may also be taken as a%erage processing period may thus
be calculated from past records. The estimated requirements of the unit under this head
may be related to its pro#ected figures as in case of raw material etc. The calculation will,
howe%er, be based on the basis of cost of production which is the most acceptable
principle of %aluation of stocks"in"process.

I& % $$$$$$$$$% month:s finished goods

The stocking period of finished goods may also be different for different types of units
and will mainly depend upon the market conditions. The %aluation of finished goods also
possess a little problem and most accepted principle is for their %aluation in terms of cost
of sale which is calculated as under

(ost of sale ) ;pening stock of finished goods / (ost of production" (losing stocks of
finished goods.
(ost of sale is also equal to net sales minus gross profit.
A%erage period of stocking of finished goods may be calculated with the help of the
following formula&

A%erage period of stocking of finished goods in months ) A%erage stock of finished
goods
<<<<<<<<<<<<<<<<<<<<<<<<<
0onthly cost of sales during the
year
where,

A%erage stock of finished goods ) ;pening stock of finished goods /(losing stock
of finished goods
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
?
and

0onthly cost of sales during the year ) (ost of sales
<<<<<<<<<<<
2?

This period would gi%e an indication as to the a%erage period of stocking of finished
goods by the unit on the basis of its past performance. This a%erage period so found may
now be related to the pro#ected figures to find out the estimated requirement under this
category. The finished goods will, howe%er, be related to cost of sales while estimating
the requirements.

& $$$$$$% weeks/months: recei%ables representing credit sales&

All the sales by any unit may not be against cash in which case the unit would not require
any funds to be blocked under this head. A part of the sales might be effected on credit in
which case the outstanding under debtors/bills recei%able will form a part of total
working capital required by the unit. The a%erage period of blockage of funds under this
head may also likewise be calculated with the following formula&

A%erage period of credit in months ) A%erage debtors
<<<<<<<<<<<<<<<<<<<< x 2?
Total credit sales



A%erage debtors );pening balances (losing balance
;pening balance of (losing balance
of debtors / of debtors bills recei%able
/ of bills recei%able
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<< /
<<<<<<<<<<<<<<<<<<<<<<<<<<
?
?

where the figures of credit sales are not separately a%ailable, we may take total sales
figures in the denominator for the purpose of abo%e calculation.

After determining the a%erage period of credit sales, the requirement of the unit under
this head may be related to the pro#ected figures.

&' $$$$$$% ;ne month:s manufacturing and administrati%e expenses

The unit has to meet the running, manufacturing and establishment expenses during the
period of manufacture and necessary pro%ision for funds required for this purpose is
necessary. The monthly a%erage expenditure can be determined by di%iding total
manufacturing and administrati%e expenditure during the last year by 2?. .uitable
ad#ustment in the anticipated expenditure for the next year may be necessary as per the
pro#ected figures.

The total of items 'o. I to 9I is the requirement of the unit for working capital at the
gross le%el. The unit raises resources to meet these requirements from many sources
besides the liquid surplus already a%ailable with the unit The resources generally
a%ailable at the command of the unit may be as under&

CREDIT AVAILABLE ON PURCHASES

All the goods may not be purchased by any unit against cash and the concern may a%ail
credit for few purchases. The credit a%ailable from the market will reduce the
requirement of the unit for working capital.

(reditors may be treated in the same manner as debtors while determining a%ailability to
the unit under this component. A%erage period of credit a%ailable to the unit may be
determined according to the following formula&

A%erage period of credit in months ) A%erage creditors
<<<<<<<<<<<<<<< x 2?
Total credit purchases

A%erage creditors );pening balances (losing balance
;pening balance of (losing balance
of creditors / of creditors bills payable
/ of bills payable
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<< /
<<<<<<<<<<<<<<<<<<<<<<<<<<
?
?

!here figures for credit purchases are not separately a%ailable, the figure of total
purchases may be taken in the denominator for the purpose of the abo%e calculations.
After determining the a%erage number of days for which credit is a%ailable, it should be
possible to determine the a%erage total credit a%ailable to the unit by relating it to the
pro#ected figures.

ADVANCE PAYMENT RECEIVED

Ad%ance payment for sales may sometimes be recei%ed which means that additional
funds are a%ailable with the unit there by reducing its working capital requirements. Any
such ad%ance payments that are recei%ed by the unit must be accounted for while
determining the actual requirement.

LIQUID SURPLUS

The concept of liquid surplus has already been explained and it represents excess of
current assets o%er current liabilities thereby meaning that some long"term liabilities ha%e
already been utilised by the unit for creation of current assets. This is also one concept of
margin being pro%ided by the unit for working capital as already explained.

Ad#ustments made in the gross working capital as already calculated for the abo%e three
items will gi%e an idea of net working capital requirements of the unit which may be
a%ailed from the bank".

The banks may not be willing to finance all the components of working capital which
ha%e been taken into consideration for calculation of gross working capital requirements.
The manufacturing and administrati%e expenses may not be financed by the bank. $anks
also stipulate margin requirements, the other concept of margin, on the %alue of security
of raw materials, semi finished and finished goods etc. while sanctioning the limits.
$anks may be willing to finance sales operation by purchasing/discounting bills
recei%able and may not be %ery keen to finance Cook debts or a %ery high margin may be
stipulated for such ad%ances. The following method is generally adopted by the banks for
fixing limits on %arious components of working capital &

'% Ra( Material & (redit to the unit is generally a%ailable for purchase of raw material
and the same is to be deducted while fixing credit limit against raw material. The margin
applicable for raw material is low in comparison to the margin applicable for semi
finished and finished goods. The margin ranging from 2D to ?D7 may be fixed depending
upon the nature of the material and standing of the unit.

II. Store and Spare & A small limit is granted against stores and spares and these are
generally included as a part of raw material only for the purpose of calculating the credit
limits. If a separate limit is sanctioned, it will be treated in the same manner as limit
against raw materials.

III. Se!i)fini*ed good & .emi"processed goods do not form a good security as its
realisable %alue cannot be exactly determined. A higher margin upto E67 may be insisted
upon by the bank while fixing a credit limit against stocks in process.

I&. Fini*ed good & The margin stipulated on finished goods may generally be higher
than the margin on raw material and may be lower than that stipulated for stocks" in
"process.

&% +ill recei,a-le.-ook de-t/ $anks generally prefer to grant facilities against bills
recei%able and a %ery low or no margin may be stipulated for supplies to -o%ernment or
other sundry parties. For finance against book debts margin stipulation may be as high as
D67 and only a small limit may be permitted.

'o bank ad%ance is granted against manufacturing and administrati%e expenses which are
to be borne by the unit itself. !e ha%e thus calculated the actual working capital
requirements by the unit and also the limits sanctioned there against by the banks.
1ifferent considerations are in%ol%ed while arri%ing at these figures and it may
sometimes be possible that limits sanctioned by the bank are not adequate and are not
equal to the total working capital requirements. The unit has to in%estigate as to the
reasons for such happening and has to take correcti%e steps, if possible or to bring in
more funds in the business to correct the situation.

!e ha%e made detailed analysis of the balance sheet of a company in Appendix 2E.2
gi%en at the end of chapter 2E and will now attempt to assess the working capital of the
unit on the basis of abo%e discussion. It may, howe%er, be mentioned e%en at the sake of
repetition that in actual practice assessment is done on the basis of pro#ected figures of
sales for the next year. In this exercise also we ha%e presumed a uniform increase of
about 267 in all the figures for the next year.

+All figures are taken in
8upees in lakhs.,

I . raw material requirement&
+Figures a%ailable in .chedule 3,

A%erage stock of ) ;pening balance of raw material / (losing
stock of raw material
raw material
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
) EDF.?B /CD?.GG
?
) DDD.D6

A%erage monthly
consumption of raw
material during the year ) ;pening stock of raw material / Total purchase "
(losing stock of raw material
2?
) EDF.?B / BBCE.CB H CD?.GG
2?
) ?CE.2G per month

A%erage stocking period in months ) A%erage stock of raw material
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<
A%erage monthly consumption of 8.0.
) DD6.D6
?CE.2G
) ?.2 months +app.,



?.2 months is thus the a%erage stocking period for raw material by the unit. =resuming
the same le%el of production but anticipating a general increase of 267 in all factors of
production due to inflation and other such reasons the raw material requirement of the
unit will thus be worked out as under&

?.2 months: requirement of raw material
) ?.2 x ?I6.DF ) C26.??

II$$$$$weeks/months stores and spares &

A%erage stock of stores and spares ) I.IB /G.FD
?
) 2G.GF
?
) F.FI



A%erage monthly consumption figures are not a%ailable and the requirement of the
unit against stores and spares may be taken as equi%alent to 8s. 26 lacs after
pro%iding necessary increase of about 267 as already discussed.

III . JJJJ. weeks: stocks in process&

(ost of production ) B,IB?.F?
!eekly cost of production ) B,IB?.F?
D?
) GD.CB
A%erage stocks in process ) 2FF.I?/?2D.6F
?
) ?6?
A%erage period of process ) A%erage stock in process
!eekly cost of production
) ?6? x D?
BIB?.F?
) ?.CF weeks
The requirement of the unit for stock in process after pro%iding the 267 increase o%er the
last year figures would amount to

?.CF weeks stocks in process i.e., cost of production
) ?.CF x EB?C.2
D?
) ???.IC

I& $$$$$% months: finished goods&

(ost of sale ) ;pening stock of finished goods / (ost of
production" (losing stocks of finished goods.
= BFD.GB / B,IB?.F? " EFB.I? ) B,FBE.CB

A%erage stocks of finished goods ) ;pening stock of Finished goods/
(losing stocks of finished goods
?
= BFD.GB / EFB.I?
2
) EBE.F?
A%erage period of stocking of
finished goods in months ) A%erage stocks of finished goods
(ost of .ales
) EBE.F? x 2?
BFEB.CB
= 2.BC months.

After pro%iding 267 increase under this factor also the requirement of the unit under this
component would be
2.BC months of finished goods i.e., cost of sale ) 2.BC x E,?2F.6I
2?
) EGF.6D
&JJJJweeks/months bill 8ecei%able representing credit sale

The figures of opening balance of bills recei%able/debtors are not gi%en and the figures as
per the balance sheet only is taken to find out the requirement of the unit. The figures of
credit sales are also not separately gi%en and hence figures of total sales are taken for this
purpose&


A%erage period of credit in months ) A%erage 1ebtors
.ales
) GBF.G 2?
EFB?.DG

)2.FB

The requirement of the unit for bills recei%able and debtors will now be computed as
under&
2.FB months of bills recei%able of sales after pro%iding pro#ected increase of 26
7.
) 2.FB x D,B2D.F?
2?
) F2?.DC
&I% $$$$$$%% ;ne months manufacturing and administrati%e expenses

Total operating expenses ) 2?22.B?

>xpenses for one month ) 2?22.B?
2?
) 266.IE

Anticipated expenses in the next you
after pro%iding for 267 increase ) 222.66



CREDIT AVAILABLE FOR PURCHASE

Figures of opening balances under creditors are not gi%en and necessary calculations
are made on the same basis as in case of sundry debtors.

A%erage period of credit a%ailable ) A%erage (reditors
x 2?
in months =urchases
) BIE.FD x 2?
BBCE.CB

(redit a%ailable for purchases to the unit ) 2.E2 month

2.E2 months of credit after pro%iding
pro#ected increase of 267 ) 2.E2 x BG62.6I
2?
) EBE.BB
) EBE.BB
!e may now proceed to compute the total working capital requirements for the unit as
under &

!orking capital requirements
8s. in lacs

?.2 months requirements of raw materials
C26.??
" months requirement of stores and spares
26.66
?.CF weeks requirement of"stocks in process
???.IC
2.BC months: of finished goods
EGF.6D
2.FB months: of bills recei%able 5 sundry debtors
F2?.DC
2 month:s manufacturing and administrati%e expenses
222.66
<<<<<<<<<<
Total requirement
??EE.GI
<<<<<<<<<<

*ess &

(redit a%ailable on purchases and ad%ance payments recei%ed
EBE.BB
*iquid surplus/net working capital a%ailable in business
+(urrent Assets " (urrent *iabilities,
?66.IF
+After making ad#ustment for 267 increase,
<<<<<<<<<<<<
'et working capital requirements
+A,2C6I.EF
<<<<<<<<<<<<<
Per!ii-le +ank Li!it

8aw material C26.??
*ess credit a%ailable EBE.BB
2GD.FI
*ess margin K ?D7 EB.IG
<<<<<<<<<<<<
2B2.I?

.tock in process ???.IC
*ess margin K E67 FI.2F
2BB.GF

Finished goods EGF.6D
*ess margin K B67 2EB.E2
<<<<<<<<<<<<<
BBE.CE
8ecei%able
$ook debts " E2?.DC
0argin K D67 ?6C.?F
$ills 8ecei%ables " E66
0argin H 'il E66.66
<<<<<<<<<<<<<
C6C.?F
<<<<<<<<<<<<<<<
Total *imits
+$, 2?6C.C?
<<<<<<<<<<<<<
'et working capital requirement
2C6I.EF
=ermissible bank limits
2?6C.C?

1eficit ) 2C6I.EF " 2?6C.C?
) E6?.FC

The unit is now faced with a deficit of 8s. E6?.FC lacs in working capital and the
%arious options a%ailable to the unit to meet this deficit may be as follows &

To arrange for additional capital to that extent to wipe off the deficit.
To arrange for long"term loans/deposits to strengthen the long"term
resources of the unit to pro%ide necessary margin for working capital.
To critically examine the le%el of current assets held by the unit. It may
be possible that the unit may be able to work with lower in%entory and may make
some earnest efforts to quickly realise its debtors thereby reducing the le%el of
working capital requirements of the unit itself.
To negotiate with the bank to reduce margin requirements so that
additional limits are a%ailable thereby reducing the deficit.

A package measure consisting of one or all of these steps is necessary to impro%e the
working condition