MBA 1st YEAR

SEM – II
202 - FINANCIAL MANAGEMNET
CHAPTER 3
WORKING CAPITAL

WORKING CAPITAL:

Working capital represents a company's ability to pay its current

liabilities with its current assets. Working capital is an important
measure of financial health since creditors can measure a company's
ability to pay off its debts within a year.

Working capital represents the difference between a firm’s current assets

and current liabilities. The challenge can be determining the proper
category for the vast array of assets and liabilities on a corporate balance
sheet and deciphering the overall health of a firm in meeting its short-
term commitments.

COMPONENTS OF WORKING CAPITAL:

CURRENT ASSETS:
This is what a company currently owns—both tangible and
intangible that it can easily turn into cash within one year or
one business cycle, whichever is less. More obvious categories
include checking and savings accounts; highly liquid marketable
securities such as stocks, bonds, mutual funds and ETFs; money market
accounts; cash and cash equivalents, accounts receivable, inventory, and
other shorter-term prepaid expenses. Other examples include current
assets of discontinued operations and interest payable. Current assets
do not include long-term or illiquid investments such as certain hedge
funds, real estate, or collectibles.

CURRENT LIABILITIES:
In similar fashion, current liabilities include all the debts and
expenses the firm expects to pay within a year or one business cycle,
whichever is less. This typically includes all the normal costs of running
the business such as rent, utilities, materials and supplies; interest or
principal payments on debt; accounts payable; accrued liabilities;
and accrued income taxes. Other current liabilities
include dividends payable, capital leases due within a year, and long-
term debt that is now coming due.

OPERATING CYCLE:

This is the chronological sequence of events in a manufacturing company in

regard to working capital. We know that working capital is the excess of
current assets over current liabilities. In reality such excess of current assets
over current liabilities may be either more or less than the working capital
requirement of the company. Accordingly it is necessary to calculate the
working capital of the company. This is illustrated with an example. Such
computation of working capital requirement may also be necessary for
planning increase of sales from existing level.

The operating cycle is the length of time for a company to acquire materials,
produce the products, sell the products, and collect the proceeds from
customers. The normal operating cycle is the average length of time for a
company to acquire materials, produce the products and collect the proceeds
from customers.

From the above it is very clear that the working capital is required to meet
the time-gap between the raw materials and actual realisation of stocks. This
time gap is technically termed as operating cycle or working capital cycle. The
operating cycle can be sub-divided into two on the basis of the nature of the
business namely trading cycle and manufacturing cycle.

Trading Cycle

Trading business does not involve any manufacturing activities. Their activities
are limited to buying finished goods and selling the same to consumers.
Therefore operating cycle requires a short time span behaviour cash to cash,
the requirement of working capital will be low because very less number of
processes in the operation is given below:

Cash Inventories Debtors Bills Receivable Cash

In the case of trading firm the operating cycle includes time required to convert

1. Cash into inventories

2. Inventories into debtors

3. Debtors into cash.

In the case of financing firm, the operating cycle is still less when compared to
trading business. Its operating cycle includes time taken for

1. Conversion of cash into suitable borrowers and

2. Borrowers into cash.

Example 1

You have invested Rs.50,000 in your company on 1.1.2006 for buying and selling of
color TVs assuming:

1. Inventory costing Rs. 50,000 is purchased at the beginning of each month.

2. All of the TVs were sold at the end of each month on cash for Rs. 60,000

1. What is the operating cycle of the company?

The answer is 30 days

2. If the sales are made on account (credit) of 30 days terms what is the
operating cycle of the company?

The answer is 60 days

3. Suppose when the suppliers allow 20 days term and sales are made an
account of 60 days’ term. What is the operating cycle of the company?

The answer is 70 days (30+60-20)

In the above all cases one could see how much retained earnings are available
for dividends.

Importance of operating cycle

If a company can shorten the operating cycle, cash can accumulate more quickly, and
due to the time value of money, there should be a positive impact on the share value.
Holding everything else constant, an investor would prefer a company with a short
operating cycle to a similar company with a longer operational cycle.

The formula to calculate operating cycle

Operating cycle = Age of inventory + collection period

Net operating cycle = Age of inventory + collection period – deferred payments

For calculating net operating cycle, various conversion periods may be calculated as
follows:

Raw material cycle period (RMCP)= (Average Raw material stock/Total raw material
Consumable) x 365

Working progress cycle period (WPCP) = (Average work in progress/ Total cost of
Production) x 365

Finished goods cycle period (FGCP) = (Average finished goods/Total cost of goods Sold)
x 365

Accounts receivable cycle period (ARCP) = (Average Account receivable/Total of

sales) x 365

Accounts payable cycle period (APCP) = (Average account payable/ Total credit
purchase) x 365

where,
Total credit purchase = cost of goods sold + ending inventory – beginning of
inventory

For above calculations, the following points are essential

1. The average value is the average of opening balance and closing balance of the
respective items. In case the opening balance is not available, only the closing balance
is taken as the average.

2. The figure 365 represents number of days in a year. Sometimes even 360 days are
considered.

3. The calculation of RMCP, WPCP and FGCP the denomination is taken as the total
cost raw material consumable, total cost of production total, cost of goods sold
respectively since they form respective end products.

On the basis of the above, the operating cycle period:

Total operating cycle period (TOCP) = RMCP + WPCP + FGCP + ARCP

Net operating cycle period(NOCP) = TOCP-DP(deferred payment) (APCP)

The operating cycle for individual components are not constant in the growth of the
business. They keep on changing from time to time, particularly the Receivable Cycle
Period and the Deferred Payment. But the company tries to retain the Net Operating
Cycle Period as constant or even less by applying some requirements such as
inventory control and latest technology in production. Therefore regular attention on
the firm’s operating cycle for a period with the previous period and with that of the
industrial average cycle period may help in maintaining and controlling the length of
the operating cycle.
Illustration 1: From the following data, compute the duration of the operating
cycle for each of the two years and comment on the increase or decrease:
Particulars 2015 2016
Stock of Raw Materials 40000 54000
Stock of Work-In-Progress 28000 36000
Stock of Finished Goods 42000 48000
Purchases 192000 270000
Cost of Goods Sold 280000 360000
Sales 320000 400000
Debtors 64000 100000
Creditors 32000 36000

Assume 360 days per year for computational purpose.

Solution: a) Computation of Operating Cycle:
Particulars 2015 2016
1. Raw Material Stock (Average (40000/192000) (54000/270000)
Raw Material / Total Purchases) x x 360 days = 75 x 360 days = 72
No. of Days in a year days days
2. Work-in-Progress (Average Work (28000/280000) (36000/360000)
in Progress / Total Cost of goods x 360 days = 36 x 360 days = 36
sold) x No. of days days days
3. Finished Goods (Average (42000/280000) (48000/360000)
Finished Goods / Total Cost of x 360 days = 54 x 360 days = 48
goods sold) x No. of days days days
4. Creditors Period (Average (32000/ 192000) (36000/270000)
Creditors / Total Purchases) x No. x 360 days = 60 x 360 days = 48
of days days days
5. Debtors (Average Debtors/ Total (64000/320000) (100000/400000)
Sales) No. of days x 360 days = 72 x 360 days = 90
days days
6. Net Operating Cycle 177 Days 198 Days

b) Increase or decrease in Operating Cycle: There is increase in length of

Operating Cycle by 21 days i.e. 12% increase approximately.
Debtors taking longer time to pay 18
(90-72) days
Creditors receiving payment earlier 12
(60-48) days
30
- Raw Material stock turnover days
lowered (75-72) 3
- Finished goods turnover lowered days
(54-48) 6
days
Increase in Operating Cycle 21
days

Illustration 2: The following information is available in respect of Weken’s

Ltd.
Particulars Amount (Rs.)
Sales 800 Lakhs
Cost of goods sold 90% of sales
Opening Inventory 96 Lakhs
Closing Inventory 102 Lakhs
Opening Debtors 86 Lakhs
Closing Debtors 90 Lakhs
Opening Creditors 56 Lakhs
Closing Creditors 60 Lakhs

Calculate the Net Operating Cycle of the company.

Solution: (a) Cost of goods sold = 90% of sales i.e. 90% of Rs. 800 lakhs i.e.
Rs. 720 Lakhs
(b) Purchases = (Closing inventory + Cost of goods sold – Opening
inventory)
= (102 + 720 – 96) = Rs. 726 Lakhs
(c) Average Inventory = (Opening Inventory + Closing Inventory / 2)
= (96 lakhs + 102 lakhs / 2) = 99 lakhs
(d) Average Debtors = (Opening Debtors + Closing Debtors /2)
= (86 lakhs + 90 lakhs /2) = 88 lakhs
(e) Average Creditors = (Opening Creditors + Closing Creditors /2)
= (56 lakhs + 60 lakhs /2) = 58 lakhs

Particulars Days

Inventory Cycle = (Average (99 lakhs / 720

Inventory/Average cost of goods sold) x No. lakhs) x 365 days =
of days 50 days
Debtors Cycle = (Average Debtors / Total (88 lakhs / 800
Credit Sales) x No. of days lakhs) x 365 days =
40 days
Creditors Cycle = (Average Creditors / Total (58 lakhs / 726
Purchases) x No. of days days) x 365 days =
29 days
Net Operating Cycle ( Inventory cycle + (50 days + 40 days
Debtors cycle – Creditors cycle_ – 29 days) = 61
days
Illustration 3: ABC Ltd. sells its products on a gross profit of 20% of sales.
The following information is extracted from its annual accounts for the year
ending 31st March 2016.

Particulars Amount
(Rs.)
Sales (at 3 months credit) 4000000
Raw Materials 1200000
Wages (15 days in arrears) 960000
Manufacturing and General Expenses (one 1200000
month in arrears)
Administration Expenses (one month in 480000
arrears)
Sales Promotion Expenses(payable half yearly 200000
in advance)

The company enjoys one month’s credit from the suppliers of raw materials
and maintains 2 months stock of raw materials and 1 ½ months finished
goods. Cash balance is maintained at Rs. 100000 as a precautionary balance.
Assuming a 10% margin, find out the working capital requirement of ABC Ltd.
Solution: Statement of Working Capital Requirement
Particulars Amount
(Rs.)

A) Current Assets:
i) Debtors (4000000 x 3/13 x 80%) (at cost of goods 800000
sold 200000
ii) Raw material stock (2/12 of 1200000) 400000
iii) Finished goods stock (1 ½ months of cost of 100000
production) 100000
iv) Advance payment of sales promotion expenses
v) Cash
Total 1600000
Current Assets
B) Current Liabilities: 100000
i) Sundry Creditors (1/12 of Rs. 1200000)
ii) Wages (arrears for 15 days) (1/24 of 960000) 40000
iii) Manufacturing & General expenses (1/12 of 100000
1200000) 40000
iv) Administration Expenses (1/12 of 480000)
Total 280000
Current Liabilities
C)Excess of Current Assets and Current Liabilities (A- 1320000
B) 132000
Add: 10% margin
D)Net Working Capital Requirement 1452000

Illustration 4: Prepare a working capital forecast from the following

information:
Production during the previous year was 1000000 units. The same level of
activity is intended to be maintained during the current year. The expected
ratios of cost to selling price are:
Raw Materials 40%
Direct Wages 20%
Overheads 20%

The raw materials ordinarily remain in stores for 3 months before production.
Every unit of production remains in the process for 2 months and is assumed
to be consisting of 100% raw material, wages and overheads. Finished goods
remain in the warehouse for 3 months. Credit allowed by creditors is 4
months from the date of delivery of raw material and credit given to debtors is
3 months from the date of dispatch.
The estimated cash balance to be held Rs. 200000
Lag in payment of wages ½ months
Lag in payment of expenses ½ month
Selling price is Rs. 8 per unit. Both production and sales are in a regular
cycle. You are required to make a provision of 10% for contingency (except
cash). Relevant assumptions may be made.
Solution: Statement of Working Capital Requirement
Particulars Amount
(Rs.)
A) Current Assets:
i)Debtors (3/12 x 8000000) x 80% 1600000
ii)Finished goods (3/12 x 8000000) x 80% 1600000
iii)Work in progress (2/12 x 8000000) 80% 1066667
iv)Raw materials (3/12 x 8000000) 40% 800000
Total Current Assets 5066667
B) Current Liabilities:
i)Creditors (8000000 x 40% x 3/12) 1066667
ii)Wages (8000000 x 20% x 1/24) 66667
iii)Expenses (8000000 x 20% x 1/24) 66666
Total Current Liabilities 1200000
C) Excess of Current Assets over Current 3866667
Liabilities 386667
Add: 10% Contingency 4253334
200000
Add: Cash Balance
D)Net Working Capital Requirement 4453334

Note: Total Sales = 1000000 units x Rs. 8 per unit = Rs. 8000000
Example 5: You are provided with the following information in respect of XYZ
Ltd. For the ensuing year:
Production for the year 69,000 units
Finished goods in store 3 months
Raw material in store 2 months
Production process 1 month
Credit allowed by creditors 2 months
Credit given to debtors 3 months
Selling price per unit Rs. 50
Raw material 50% of selling price
Direct wages 10% of selling price
Overheads 20% of selling price
There is a regular production and sales cycle and wages and overheads accrue
evenly. Wages are paid in the next month of accrual. Material is introduced in
the beginning of production cycle.
You are required to find out:
(1) Its working capital requirement
Solution: Statement of working capital requirement:
CurrentAssets
Rs. Rs.
Raw materials stock
(69000 x 25 x 2/12) 2,87,000
Working progress:
1. Raw materials
2. (69,000x25x1/2)
1,43,750
3. Direct wages
(69,000x5x1/24)
14,375
 4. Overhead
(69,000x10x1/24) 28,750
1,86,875
Finished goods:
(69000x40x3/12)
6,90,000
Debtors:
(69,000x40x3/12)
6,90,000

18,54,375
Current Liabilities:
Creditors Raw materials
69,000 x25x2/12 2,87,500
Outstanding Wages
69,000 x 5 x 1/12 28,750

3,16,250
Working capital requirement
= 15,38,125
Assumptions: Debtors are taken at cost price not at selling price.

Illustration 6: A Proforma cost sheet of a company provides the following

particulars:
Elements of Cost Cost Per Unit
(Rs.)
Raw Material 80
Direct Labour 30
Overheads 60
Total cost of 170
Production
Profit 30
Selling Price 200

Following further particulars are available:

i) Raw Materials are in stock on an average one month.
ii) Materials are in process on an average half a month.
iii) Finished goods are in stock on an average one month.
iv) Credit allowed by suppliers is one month.
v) Credit allowed to debtors is two months.
vi) Lag in payment of wages and overheads are one month.
vii) One fourth of the output is sold against cash.
viii) Cash on hand and at bank is expected to be Rs. 25000.
You are required to prepare a statement showing the working capital needed
as per total approach method of working capital to finance a level of activity of
60000 units of production annually. The production is carried out evenly
throughout the year.

Solution: Statement Showing the Working Capital

Requirement
(Total Approach Method)
Particulars Amount
A) Current Assets:
Stock of Raw Materials (60000 units x Rs. 80 per unit) x 400000
1/12 425000
Stock of Work in Progress (Working Note) 850000
Stock of Finished Goods (60000 units x Rs. 170 per unit) x 1500000
1/12 25000
Debtors (60000 units x Rs. 200 per unit) x(2/12)x 3/4
Cash at Bank
Total Current Assets 3200000
B) Current Liabilities
Creditors (60000 units x Rs. 80 per unit) x1/12 400000
Wages (60000 units x Rs. 30 per unit) x 1/12 150000
Overheads (60000 units x Rs. 60 per unit) x 1/12 300000
Total Current Liabilities 850000
C) Net Working Capital (A-B) 2350000

Notes: 1) Debtors are calculated on selling price.

1) Calculation of Work in Progress:
Raw Material (60000 units x Rs. 80 per 200000
unit) x 0.5/12 75000
Direct Labour (60000 units x Rs. 30 per 150000
unit) x 0.5/12
Overheads (60000 units x Rs. 60 per unit)
x 0.5/12
Work in Progress 425000

Illustration 7: The cost structure of a company’s product is as follows:-

Cost Per Unit Amount
(Rs.)
Raw Material 20
Direct Labour 5
Overheads 15
Total cost of 40
Production
Profit 10
Selling Price 50
i) The annual production is 240000 units.
ii) It is the policy of the company is to maintain the stock of raw materials
equivalent to one month’s production.
iii) Half a month’s production will remain in process throughout the year
(Stage of completion 50%).
iv) The finished goods remain in warehouse on an average for a month.
v) The company sells its goods on credit and allows two months credit to
its customers.
vi) The suppliers of raw materials provide 3 months credit to the company.
vii) The period of lag for wages and overheads is one month.
viii) A minimum cash balance of Rs. 25000 is expected to be maintained.
You are required to prepare a statement showing working capital requirement
as per cash cost approach method of working capital estimation.
Solution: Statement Showing the Working Capital
Requirement
(Cash Cost Approach)

Particulars Amount
A) Current Assets:
Stock of Raw Materials (240000 units x Rs. 20 per unit) x 400000
1/12 300000
Stock of Work in Progress (Working Note) 800000
Stock of Finished Goods (240000 units x Rs. 40 per unit) x 1600000
1/12 25000
Debtors (240000 units x Rs. 40 per unit) x(2/12)
Cash at Bank
Total Current Assets 3125000
B) Current Liabilities
Creditors (240000 units x Rs. 20 per unit) x3/12 1200000
Wages (240000 units x Rs. 5 per unit) x 1/12 100000
Overheads (240000 units x Rs. 15 per unit) x 1/12 300000
Total Current Liabilities 1600000
C) Net Working Capital (A-B) 1525000
Note: 1) Debtors are calculated on total cost excluding profit.
2) Calculation of Work in Progress:
Raw Material (240000 units x Rs. 20 per unit)
x 0.5/12 200000
Direct Labour (240000 units x Rs.5 per unit) x 25000
0.5/12 x 50%
Overheads (240000 units x Rs. 15 per unit) x 75000
0.5/12 x 50%
Work in Progress 300000

Illustration 8: A Proforma cost sheet of a company provides the following

data:
Cost Per Unit Rs.
Raw Material 20
Direct Labour 8
Overheads 15
Total cost 43
Profit 7
Selling Price 50

The following is the additional information available:

Average raw material in stock: one month;
Average work in process: half a month;
Finished goods in stock: on average one month;
Credit allowed to debtors: 2 months;
Credit allowed by suppliers: one month;
Time lag in payment of wages: one month;
Time lag in payment of overheads: one month;
Cash balance is expected to be Rs. 90000.
You are required to prepare a statement showing working capital needed to
finance a level of activity of 52000 units of output as per Total Approach
method of working capital estimation. You may assume that production is
carried on evenly throughout the year and wages and overheads accrue.
Solution: Statement Showing Working Capital Requirement:
Particulars Amount (Rs.)
A) Current Assets:
Stock of Raw Materials ( 52000 units x Rs. 20 per unit) x 86667
1/12 93167
Stock of Work in Progress ( Working note) 186333
Stock of Finished Goods (52000 units x Rs.43 per unit) x 433333
1/12 90000
Debtors (52000 units x Rs. 50 per unit) x 2/12
Cash Balance
Total Current Assets 889500
B) Current Liabilities:
Creditors (52000 units x Rs. 20 per unit) x 1/12 86667
Wages (52000 units x Rs. 8 per unit) x 1/12 34667
Overheads (52000 units x Rs. 15 per unit) x 1/12 65000
Total Current Liabilities 186333
C) Working Capital (A-B) 703167

Notes: 1) for calculation of debtors selling price is considered. Alternatively

debtors can be calculated on the basis of cost of goods sold.
1) Calculation of Work in Progress:
Raw Material (52000 units x Rs. 20 per 43333
unit) x 0.5/12 17334
Direct Labour (52000 units x Rs. 8 per unit) 32500
x 0.5/12
Overheads (52000 units x Rs. 15 per unit) x
0.5/12
Work in Progress 93167

Illustration 9:Namo Ltd. is commencing a new project to manufacture a

plastic component. The following per unit cost information has been
ascertained for annual production of 104000 units.
Cost Per Unit Rs.
Raw Material
80
Direct Labour
30
Overheads (including Depreciation of Rs.
10 per unit) 60
Total Cash Cost 170
Additional Information:
i) Selling price Rs. 200 per unit.
ii) Raw Materials in stock, average 4 weeks.
iii) Work in progress, average 2 weeks.
iv) Finished Goods in stock, average 4 weeks.
v) Credit allowed to customers, average 8 weeks.
vi) Credit allowed by suppliers, average 4 weeks.
vii) Lag in payment of wages, 1.5 weeks.
viii) Cash in hand expected to be Rs. 25000.
You may assume that production is carried out on evenly throughout the year
(52 weeks) and wages and overhead accrue similarly. All sales are on credit
basis only. You are required to prepare a statement showing working capital
requirement as per Cash Cost Approach method of working capital
estimation.
Solution: Statement showing the Working Capital Requirement
Cash Cost Approach Method
Particulars Amount
A) Current Assets:
Stock of Raw Materials (104000 units x Rs. 80 per unit) x
4/52 640000
Stock of Work in Progress (Working Note)
Stock of Finished Goods (104000 units x Rs. 160 per 640000
unit) x 4/52 1280000
Debtors (104000 units x Rs. 160 per unit) x 8/52 2560000
Cash
25000
Total Current Assets 5145000
B) Current Liabilities
Creditors (104000 units x Rs. 80 per unit) x 4/52
Labour (104000 units x Rs. 30 per unit) x 1.5/52 640000
Overheads (104000 units x Rs. 50 per unit) x 1.5/52
90000

150000
Total Current Liabilities
880000
C) Net Working Capital (A –B) 4265000

Notes: 1) Debtors are calculated on the basis of total cost.

2) Depreciation being a non cash expenditure not considered while computing
WIP, Finished goods, Debtors and Overheads.
3) Calculation of Work in Progress:
Raw Material (104000 units x Rs. 80 per 320000
unit) x 2/12 120000
Direct Labour (104000 units x Rs.30 per 200000
unit) x 2/12
Overheads (104000 units x Rs.50 per unit)
x 2/12
Work in Progress 640000

Illustration 10: A Proforma cost sheet of a company provides the following

particulars:
Element of Cost Cost per unit
(Rs.)
Raw Material 160
Direct Labour 60
Overheads 120
Total Cost of 340
Production
Profit 60
Selling Price 400
Following further particulars are available:
i) Raw materials are in stock for one month.
ii) Credit allowed by suppliers is one month.
iii) Credit allowed to customers is two months.
iv) Lag in payment of wages 1.5 months.
v) Lag in payment of overheads one month.
vi) Materials are in process for an average of half a month.
vii) Finished goods are in stock for an average of one month.
viii) 1/4th of output is sold against cash.
ix) Cash in hand and bank is expected to be Rs. 50000.
You are required to prepare a statement showing the working capital needed
to fiancé a level of activity of 60000 units of production annually. The
production is carried out evenly throughout the year.
Solution: Statement showing the Working Capital Requirement
(Total Approach Method)
Particulars Amount
A) Current Assets:
Stock of Raw Materials (60000 units x Rs. 160 per unit) x 800000
1/12 850000
Stock of Work in Progress (Working Note) 1700000
Stock of Finished Goods (60000 units x Rs. 340 per unit) x 2550000
1/12 50000
Debtors (60000 units x Rs. 340 per unit) x 2/12/x(3/4)
Cash at Bank
Total Current Assets 5950000
B) Current Liabilities:
Creditors (60000 units x Rs. 160 per unit) x 1/12 800000
Wages (60000 units x Rs. 60 per unit) x 1/12 300000
Overheads(60000 units x Rs. 120 per unit) x 1/12 600000
Total Current Liabilities 1700000
C) Net Working Capital (A – B) 4250000

Notes: 1) Debtors are calculated on total cost of production.

2) Calculation of Work in Progress:
Raw Material (60000 units x Rs. 160 per 400000
unit) x 0.5/12 150000
Direct Labour (60000 units x Rs.60 per 300000
unit) x 0.5/12
Overheads (60000 units x Rs.120 per unit)
x 0.5/12
Work in Progress 850000

Illustration 11: The management of Royal Industries has called for a

statement showing the working capital needs to finance a level of activity of
180000 units of output for the year. The cost structure for the company’s
product for the above mentioned activity level is detailed below:
Particulars Cost per unit
(Rs.)
Raw Materials 20
Direct Labour 5
Overheads 10
Cost of 35
Production
Profit 10
Selling Price 50

Additional Information:
i) Minimum desired cash balance is Rs. 20000.
ii) Raw materials are held in stock, on an average for two months.
iii) Work in progress (assume 50% completion stage for materials, labour
and overheads) will approximate to half a month’s production.
iv) Finished goods remain in warehouse on an average for a month.
v) Suppliers of materials extend a month’s credit. Also, Debtors collection
period is two months. Cash sales are 25% of total sales.
vi) There is a time-lag in payment of wages and overheads are of a month.
You are required to estimate the working capital requirements of the company
with assumption that production is carried on evenly throughout the year.
Solution: Statement showing the Working Capital Requirement
Particulars Amount
A)Current Assets:
Stock of Raw Materials (180000 units x Rs. 20 per unit) x 600000
2/12 131250
Stock of Work in Progress (Working Note) 525000
Stock of Finished Goods ( 180000 units x Rs. 35 per unit) x 787500
1/12 20000
Debtors (Working Note)
Cash at Bank
Total Current Assets 2063750
B) Current Liabilities:
Creditors (180000 units x Rs. 20 per unit) x 1/12 300000
Wages (180000 units x Rs. 5 per unit) x 1/12 75000
Overheads (180000 units x Rs. 10 per unit) x 1/12 150000
Total Current Liabilities 525000
C) Net Working Capital (A – B) 1538750

Notes: 1) Depreciation being non cash expenditure excluded from overheads.

2) Debtors are taken on total cost of production excluding depreciation of Rs.
5/-
3) Calculation of Work in Progress:
(180000 units x Rs. 35 per unit x 0.5/12 x (50/100) = Rs. 131250.
Illustration 12: M/s YS Reddy Ltd. submits the following details of its costs.
Calculate working capital requirements.
Particulars Cost Per
Unit (Rs.)
Raw Materials 400
Direct Labour 150
Overheads (includes 350
depreciation & amortization
Rs. 50)
Total Cost 900

Additional Data:
a) Minimum Cash Balance Rs. 40000;
b) Profit per unit Rs. 150 and output 52000 units;
c) Raw material remains in stores average 4 weeks;
d) Credit to customers average 8 weeks & received from suppliers average
4 weeks;
e) Finished goods average 4 weeks. Partly finished goods average 2 weeks.
(Stage of completion 100% material & 50% for other element of cost).

Solution: Statement Showing the Working Capital Requirement

Particulars Amount
A)Current Assets:
Stock of Raw Materials (52000 units x Rs. 400 per unit) x 1600000
4/52 1250000
Stock of Work in Progress (Working Note) 3400000
Stock of Finished Goods ( 52000 units x Rs. 850 per unit) x 6800000
4/52 50000
Debtors (52000 units x Rs. 850 per unit) x 8/52
Cash at Bank
Total Current Assets 13100000
B) Current Liabilities:
Creditors (52000 units x Rs. 400 per unit) x 4/52 1600000
Total Current Liabilities 1600000
C) Net Working Capital (A – B) 11500000

Note: Calculation of Work in Progress:

Raw Materials (52000 units x Rs. 400 per unit) x 800000
2/52 150000
Direct Labour (52000 units x Rs. 150 per unit) x 300000
2/52 x (50%)
Overheads (52000 units x Rs. 300 per unit) x
2/52 x (50%
Work in Progress 1250000

Questions

1. What do you mean by the term Working Capital?

2. Write short notes on (a) Permanent working capital (b) Gross working
capital (c) Net working capital.
3. Discuss in detail various components of working capital.
4. Explain the sources of working capital financing.
5. What are the factors that influence working capital requirements?
Explain the meaning and the significance of working capital management.
6. Explain the nature and scope of working capital.
7. Explain concept of operating cycle.
8. What are the various factors affecting on working capital?
9. What are the various sources of working capital?
10. Discuss the types of working capital in detail.
11. What are the components of working capital?
12.
Exercise 1: A Proforma cost sheer of a company provides the following data:
Cost Per Unit Rs.
Raw Materials 52.00
Direct Labour 19.50
Overheads 39.00
 Total Cost per 110.50
unit
Profit
19.50
Selling Price 130.00

The following is the additional information available:

Average raw material in stock: one month; average materials in process: half a
month; Credit allowed by suppliers: one month; Credit allowed to debtors: 2
months; Time lag in payment of wages: 1 ½ weeks; Overheads: one month;
One fourth of sales are on cash basis. Cash balance is expected to be Rs.
120000.
You are required to prepare a statement showing the working capital needed
to finance a level of activity of 70000 units of output. You may assume that
production is carried on evenly throughout the year and wages and overheads
accrue.
Exercise 2: A Proforma cost sheet of Deepali Company provides the following
data:
Cost Per Unit Rs.
Raw Materials 10
Direct Labour 4
Overheads 6
Total Cost 20
Profit 5
Selling Price 25

The following is the additional information available:

Average raw materials in stock: one month
Average work in process: half a month
Finished goods in stock: on average one month
Credit allowed to debtors: 2 months
Credit allowed by suppliers: one month
Time lag in payment of wages: one month
Time lag in payment of overheads: one month
Cash Balance is expected to be Rs. 25000.
You are required to prepare a statement showing working capital needed to
finance a level of activity of 40000 units as per Total Cost Approach method of
working capital estimation. You may assume that production is carried on
evenly throughout the year and wages and overheads accrue.
Exercise 3:Ameya Ltd. is commencing a new project to manufacture a plastic
component. The following per unit cost information has been ascertained for
annual production of 100000 units.
Cost Per Unit Rs.
Raw Materials 40
Direct Labour 15
Overheads (including depreciation of Rs. 30
5 per unit)
Total Cash Cost 85

Additional Information:
i) Selling price Rs. 100 per unit.
ii) Raw Materials in stock, average 4 weeks.
iii) Work in progress, average 2 weeks.
iv) Finished goods in stock, average 4 weeks.
v) Credit allowed to customers, average 8 weeks.
vi) Credit allowed by suppliers, average 4 weeks.
vii) Lag in payment of wages, 1.5 weeks.
viii) Cash in hand is expected to be Rs. 50000
You may assume that production is carried out on evenly throughout the year
(52 weeks) and wages and overheads accrue similarly. All sales are on credit
basis only. You are required to prepare a statement showing working capital
requirement as per Cash Cost Approach method of working capital.
Exercise 4: From the following details prepare a statement of working capital
requirements:
(a) Average amount locked up in stock:
Stock of raw materials and stores = Rs. 80000 p.a.
Stock of WIP & Finished goods = Rs. 50000 p.a.
(b) Average credit given:
Local sales – 2 week credit = Rs. 780000 p.a.
Outside the state – 6 weeks credit = Rs. 3120000 p.a.
(c) Time available for payment:
For purchases – 4 weeks = Rs. 960000 p.a.
For wages – 2 weeks = Rs. 2600000 p.a.
(d) Assume 10% for contingencies.
Exercise 5: From the following information prepare a statement showing the
estimated working capital needs in total.
Budgeted Sales Rs. 2600000
p.a.
Cost per unit: Raw Materials Rs. 25
Direct Labour Rs. 45
Overheads Rs. 20
Cost of Sales Rs. 90
Profit Rs. 10
Selling Price per Rs. 100
unit
It is estimated that (a) Raw materials will be carried in stock for two weeks
and finished goods for three weeks (b) Factory process will take four weeks (c)
Suppliers will give four weeks credit and customers will require seven weeks
credit.
It may be assumed that production and overheads arise evenly throughout
the year.
Exercise 6: A Proforma cost sheet of the company provides the following
particulars:
Elements of cost amount per unit in Rs. (as % of selling price)
Material 50%
Direct labour 10%
Overheads 10%
The following further particulars are available:
a) It is proposed to maintain a level of activity of 100000 units.
b) Selling price is Rs. 10 per unit.
c) Raw materials are expected to be in stores for an average of 2 months.
d) Materials will be in process, on average one month.
e) Finished goods are required to be in stock for an average of 2 months.
f) Credit allowed to debtors is 3 months.
g) Credit allowed by suppliers is 2 months.
Assuming 10% contingency margin, find out working capital requirement.
Exercise 7: XYZ Ltd. is a pipe manufacturing company. In production cycle,
materials are introduced in the beginning, wages and overheads accrue evenly
throughout the production cycle. Wages are paid in the next month following
the month of accrual. Work in process includes full units of raw materials and
50% of wages and overheads are supposed to be conversion cost. The other
details are given below:
Production of pipes: 12000 units
Duration of the production cycle: One month
Raw materials inventory held: One month consumption
Finished goods inventory held for: Two months
Credit allowed by creditors: One month
Credit given to debtors: Two months
Cost price of raw materials Rs. 60 per unit
Direct wages Rs. 10 per unit
Overheads Rs. 20 per unit
Selling price of pipes Rs. 100 per unit
You are required to compute working capital requirement.
Exercise 8: The data of ABC Ltd. is as under:
Production p. a. 69000 units Credit allowed to debtors: 2
Finished goods in stock: 3 months
months Selling price per unit: Rs. 50
Raw material stock: 2 months each
Production process: 1 month Raw Material: 50% of SP
Credit allowed by creditors: 2 Direct wages: 10% of SP
months Overheads:20% of SP

Wages are paid in the next month of accrual. Find out working capital
requirement on the basis of total cost approach.
Exercise 9: A company sells 3000 units of a Mixer at Rs. 2000 each. The
details of cost per unit are as follows:
Raw materials
Direct wages 800
Overhead expenses
Depreciation 400
Total Cost
Profit 300
Selling price p. u. 100
1600
400
2000

The following additional information is also available:

Raw materials in stock: 4 weeks
Work in process: 1 week
Finished goods: 1 week
Credit allowed to debtors: 6 weeks
Credit allowed by suppliers: 4 weeks
Cash balance to be maintained Rs. 60000
Calculate the net working capital requirement of the company on the basis of
cash cost approach.
Exercise 10: MDB Ltd. sells its product on a gross profit of 20% on sales. The
following information is available:
Sales at 3 months credit
Raw Materials 2000000
Wages paid 15 days in arrears
Manufacturing expenses1 month in arrears 600000
Administrative expenses 1 month in arrears
Sales promotion expenses payable ½ years in 480000
advance
Income tax payable quarterly 600000

240000

100000

200000

The company enjoys one month’s credit from supplier and maintains 2
months of stock of raw materials and 1.½ months stock of finished goods.
Cash balance is maintained at Rs. 50000. Find out working capital
requirement of the company.