Working Capital:

Estimation and Calculation

Chapter 3
Course Coordinator: Saqib Sharif
Iqra University, Gulshan Campus,
Karachi Spring 2015

Introduction
Cash inflows not matched in both timing and amount
by cash outflows
This provides us with an operating cycle and rationale
for investing in working capital
For projecting WC requirement, management must
forecast maximum level of CA to support an expected
volume of sales
And maximum level of short-term credit it can
anticipate to finance these assets

Synopsis

Estimation Procedure
WC as a %age of Net Sales
WC as a %age of Total Assets
Working Capital based on Operating Cycle
Need for cash and bank balance
Need for Inventories
Need for Receivables
Provided by creditors
Provided by outstanding wages and expenses

Estimation of WC Requirement
Working Capital Estimation and Double Shift Working

Estimation Process
Bifurcation into permanent and temporary
working capital
Helps how much be financed from long term
sources and how much be financed from short
term sources
WC as %age of net sales:
WC for any firm is directly related to the sales volume
Three steps involved in in the estimation of WC:
CA as a %age of estimated net sales
CL as a %age of estimated net sales, and
The difference b/w the above two, NWC as a %age of net
sales

Working Capital as a %age of TA or

FA
TA consists of fixed assets and current assets
Based on past experience relationship b/w total
CA or NWC and TA or TFA of the firm is
established
The estimation of WC therefore depends on FA
which depends on Capital budgeting decisions
Approach to estimate WCR is simple but difficult
to calculate
WCR of a firm depends on two variables:
Time factor, and
Value factor

WC based on Operating
Cycle (OC)
Concept of OC is uesd to estimate the WCR
Detailed analysis is made for each
component of WC and estimate is made for
each of these components
(a) Need for cash and bank balances
(b) Need for Raw materials
(c) Need for Work-in-progress
The value of RM, wages and other expenses
locked-up in semi-finished units is the WCR for
WIP

WC based on Operating
Cycle (OC)
(d) Need for finished goods
(e) Need for receivables
At any point of time firm requires GWC
as there will be some units of RM in
stores, some units in WIP, some units as
finished goods, and there will be some
debtors yet to be collected

(f) creditors for the purchases

(g) creditors for the expenses

Steps required for estimation of WC

based on OC
Identify the CA and CL to be maintained
Determine the average OC (or holding
period) for each of these elements
Find out rate per unit for each of these
elements
Find out amount (funds) expected to be
blocked for each of these elements
Prepare WC estimation sheet and find
out WCR

Points worth noting while Estimating

WCR
Depreciation
The WC is calculated by ignoring depreciation

Safety Margin
It depends on the nature and characteristics of
the firm as well as it CA and CL

Double Shift working

The requirement of RM will increase proportionately
The WIP of first shift continue in the second shift
The cost of RM and selling price per unit of FG may
decrease

Estimation of WC
Requirements

I.

Current Assets:

Amount

Amount

Amount

Minimum Cash Balance

****

Inventories:

Raw Materials

****

Work-in-progress

****

Finished Goods

****

****

Receivables:

Debtors

****

Bills

****

****

Gross Working Capital (CA)

****

****

II.

Current Liabilities:

Creditors for Purchases

****

Creditors for Wages

****

Creditors for Overheads

****

Total Current Liabilities (CL)

****

****

Excess of CA over CL

****

+ Safety Margin

****

Net Working Capital

****