1

FINANCIAL MANAGEMENT II
CHAPTER 2 PRINCIPLES OF WORKING CAPITAL
MANAGEMENT
 WORKING CAPITAL MANAGEMENT
2

 Working capital (or short-term financial) management is

the management of current assets and current liabilities.
 Working capital management is concerned with the
problems that arise while managing current assets,
current liabilities, and inter-relationship that exists
between them.
 Firms are able to reduce financing costs or increase
the funds available for expansion by minimizing the
amount of funds tied up in working capital.
 WORKING CAPITAL MANAGEMENT
3

 Working capital management involves two basic questions:

1. What is the appropriate amount of current assets, both in
total and for each specific account.
2. How should those current assets be financed.
 Working capital management: Includes both establishing
working capital policy and then the day-to-day control of cash,
inventories, receivables, accruals, and accounts payable.
 Working capital policy:
 The level of each current asset.
 How current assets are financed.
 LONG AND SHORT TERM
ASSETS & LIABILITIES
4

Current Assets: Current Liabilities:

Cash A ccounts Payable
M arketable Securities A ccruals
Prepayments Short-Term D ebt
A ccounts Receivable Taxes Payable
Inventory

Fixed Assets: Long-Term Financing:

Investments D ebt
Plant & M achinery Equity
Land and Buildings
 WORKING CAPITAL MANAGEMENT
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 Current assets: in ordinary course of business, can be converted

into cash within one year without undergoing any diminution on in
value. E.g., cash, marketable securities, accounts receivable, and
inventory
 Fixed assets: permanent in nature and are held for use in business

activities. E.g., land, building, machinery etc.

 Current liabilities: obligations that have to be paid in a single

accounting period. E.g., accounts payable, bills receivable,

bank over-draft and outstanding expenses
 Long-term liabilities: obligations that can be repaid over a period

greater than a single accounting period. E.g., share capital,

debentures, long-term loans etc.
 WORKING CAPITAL MANAGEMENT
6

 Working capital management encompasses the day-to-

day activities of managing the firm’s current assets and
current liabilities. Examples of working capital decisions
include:
 How much inventory should a firm carry?
 Who should credit be extended to?
 Should inventories be bought on credit or cash?
 If credit is used, when should payment be made?
 WORKING CAPITAL MANAGEMENT
7

 Working capital management is financing and controlling the

investment in the current assets of a firm
 Working capital management refers to choosing the levels and
mix of:
 cash, marketable securities, receivables and inventories.
 different types of short-term financing.
 Sales growth often leads to a buildup in inventory and accounts
receivable. Firm may require additional external financing
 Goal is to achieve a balance between liquidity and profitability

that contributes positively to the firm’s value.

 Crucial to short-term success or failure of a business
 MANAGERS WHO DEAL WITH SHORT-
TERM FINANCIAL PROBLEMS
8

Duties related to short-term

Title of manager financial management Assets/liabilities influenced

Cash manager Collection, concentration, disbursement; Cash, marketable short-term investments; short-term
borrowing; securities, short-term loans
banking relations
Credit manager Monitoring and control of accounts Accounts receivable
receivable; credit policy decisions
Marketing manager Credit policy decisions Accounts receivable
Purchasing manager Decisions on purchases, suppliers; may Inventory, accounts payable
negotiate payment terms
Production manager Setting of production schedules and Inventory, accounts payable
materials requirements
Payables manager Decisions on payment policies and on Accounts payable
whether to take discounts
Controller Accounting information on cash flows; Accounts receivable, reconciliation of accounts payable;
application accounts payable
of payments to accounts receivable
 OBJECTIVE OF WORKING CAPITAL
9 MANAGEMENT
The goal of working capital management is to manage the
current assets and liabilities in such a way that an acceptable
level of net working capital is maintained. There are two
issues that are dealt under working capital.
1) Determining the level of working capital to be maintained.
2) Decision regarding financing of current assets.
 OBJECTIVE OF WORKING CAPITAL
MANAGEMENT
10

 To run firm efficiently with as little money as possible tied up in

Working Capital
 Involves trade-offs between easier operation and cost of carrying

short-term assets
 Benefit of low working capital
 Money otherwise tied up in current assets can be invested
in activities that generate higher payoff
 Reduces need for costly financing
 Cost of low working capital
 Risk of shortages in cash, inventory
 WORKING CAPITAL TRADE-OFFS
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Inventory
HIGH LEVELS LOW LEVELS
Benefit: Cost:
 Happy customers • Shortages
 Few production delays (always have needed parts on • Dissatisfied customers
hand)
Cost: Benefit:
• Expensive • Low storage costs
• High storage costs • Less risk of obsolescence
• Risk of obsolescence
Cash
HIGH LEVELS LOW LEVELS
Benefit: Benefit:
• Reduces risk • Reduces financing costs
Cost: Cost:
• Increases financing costs • Increases risk
 WORKING CAPITAL TRADE-OFFS

12
Accounts Receivable
High Levels (favorable credit terms) Low Levels (unfavorable terms)
Benefit: Cost:
• Happy customers • Dissatisfied customers
• High sales • Lower Sales
Cost: Benefit:
• Expensive • Less expensive
• High collection costs
• Increases financing costs
Accounts Payable and Accruals
High Levels Low Levels
Benefit: Benefit:
• Reduces need for external finance--using a • Happy suppliers/employees
spontaneous financing source Cost:
Cost: • Not using a spontaneous financing
• Unhappy suppliers source
 THE TRADEOFF BETWEEN
PROFITABILITY AND RISK
13

 Positive Net Working Capital (low return and low risk)

low cost
Current Current
low
Assets Liabilities
return Net Working
Capital > 0
high cost
Long-Term
Debt

high
return Fixed
Assets Equity highest
cost
 THE TRADEOFF BETWEEN
PROFITABILITY AND RISK (CONT.)
14

 Negative Net Working Capital (high return and high risk)

low
Current Current
return Assets Liabilities low cost
Net Working
Capital < 0

Long-Term
high Debt high cost
return
Fixed
Assets Equity
highest
cost
 WORKING CAPITAL TRADE-OFFS

Current Assets High Level Low Level

Profitability Lower Higher

Risk Lower Higher

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 THE TRADEOFF BETWEEN
PROFITABILITY AND RISK (CONT.)
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Table Effects of Changing Ratios on Profits and Risk

 WORKING CAPITAL POLICY
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 Firm must set policy on following issues:

 How much working capital is used
 Extent to which working capital is supported by short- vs. long-
term financing
 How each component of working capital is managed
 The nature/source of any short-term financing used
 The size and nature of investment in current assets is a
function of different factors such as type of products
manufactured, the length of operating cycle, the sales level,
inventory policies, unexpected demand and unanticipated
delays in obtaining new inventories, credit policies and current
assets.
 WORKING CAPITAL POLICY
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 The amount of operating current assets held is a policy

decision, and one that affects profitability.
 There are three alternative policies regarding the size of the
firm’s operating current assets.
 A relaxed policy
 A restricted policy
 A moderate policy
 WORKING CAPITAL POLICY
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 Relaxed working capital policy.

Under this policy, a firm would hold relatively large amounts
of each type of current asset
 Restricted working capital policy.
The firm would hold minimal amounts of these items.
 Moderate working capital policy
 WORKING CAPITAL POLICY:
RELAXED WORKING CAPITAL POLICY
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 Relatively large amounts of cash and inventories.

 Sales are stimulated by the use of a credit policy that
provides liberal financing to customers and a
corresponding high level of receivables
 A company doesn’t take advantage of credit provided by
accruals and accounts payable
 Can be applied under conditions of uncertainty, when
sales, costs, lead times, payment periods, and so on, are
not known for sure.
 WORKING CAPITAL POLICY:
RESTRICTED WORKING CAPITAL POLICY
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 The holdings of cash, inventories, and receivables are

minimized
 Accruals and payables are maximized.
 Under the restricted policy, NOWC is turned over more
frequently, so each dollar of NOWC is forced to “work harder.”
 WORKING CAPITAL POLICY:
MODERATE WORKING CAPITAL POLICY

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 Between the two extremes.

 WORKING CAPITAL POLICIES
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Optimal Amount (Level) of Current Assets

Assumptions
 50,000 maximum units of Policy A

ASSET LEVEL ($)

production Policy B
 Continuous production Policy C
 Three different policies
for current asset levels Current Assets
are possible

0 25,000 50,000
OUTPUT (units)
24
IMPACT ON LIQUIDITY

Optimal Amount (Level) of Current Assets

Liquidity Analysis
Policy Liquidity Policy A

ASSET LEVEL ($)

A High Policy B

B Average Policy C
C Low
Greater current asset levels Current Assets
generate more liquidity; all
other factors held constant.
0 25,000 50,000
OUTPUT (units)
 IMPACT ON EXPECTED
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PROFITABILITY

Optimal Amount (Level) of Current Assets

Return on Investment =
Net Profit Policy A

ASSET LEVEL ($)

Total Assets Policy B
Let Current Assets = (Cash + Policy C
Rec. + Inv.)

Return on Investment = Current Assets

Net Profit
Current + Fixed Assets
0 25,000 50,000
OUTPUT (units)
IMPACT ON EXPECTED
PROFITABILITY
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Optimal Amount (Level) of Current Assets

Profitability Analysis
Policy Profitability Policy A

ASSET LEVEL ($)

A Low Policy B

B Average Policy C
C High
As current asset levels decline, Current Assets
total assets will decline and the
ROI will rise.
0 25,000 50,000
OUTPUT (units)
 IMPACT ON RISK
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Optimal Amount (Level) of Current Assets

 Decreasing cash reduces the
firm’s ability to meet its financial Policy A
obligations. More risk!

ASSET LEVEL ($)

Policy B
 Stricter credit policies reduce Policy C
receivables and possibly lose
sales and customers. More risk!
Current Assets
 Lower inventory levels increase
stockouts and lost sales. More
risk! 0 25,000 50,000
OUTPUT (units)
 IMPACT ON RISK
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Optimal Amount (Level) of Current Assets

Risk Analysis
Policy Risk Policy A

ASSET LEVEL ($)

A Low Policy B

B Average Policy C
C High
Current Assets
Risk increases as the level of
current assets are reduced.
0 25,000 50,000
OUTPUT (units)
 SUMMARY OF THE OPTIMAL
AMOUNT OF CURRENT ASSETS
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SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS

Policy Liquidity Profitability Risk
A High Low Low
B Average Average Average
C Low High High

1. Profitability varies inversely with liquidity.

2. Profitability moves together with risk. (risk and return
go hand in hand!)
 WORKING CAPITAL AND FUNDING
REQUIREMENTS
30

 Working Capital Requires Funds

 Maintaining working capital balance requires permanent
commitment of funds
 Example: Firm will always have minimum level of Inventory,
Accounts Receivable, and Cash—this requires funding
 WORKING CAPITAL
NEEDS OF DIFFERENT FIRMS
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 PERMANENT AND TEMPORARY
32
WORKING CAPITAL
 There is always a minimum level of ca which is continuously required
by a firm to carry on its business operations.
 Thus , the minimum level of investment in current assets that is
required to continue the business without interruption is referred as
permanent working capital.
 Working capital is permanent to the extent that it supports constant or
minimum level of sales.
 Temporary working capital supports seasonal peaks in business.
This is the amount of investment required to take care of fluctuations
in business activity or needed to meet fluctuations in demand
consequent upon changes in production and sales as a result of
seasonal changes.
 PERMANENT WORKING CAPITAL
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The amount of current assets required to meet a firm’s long-term minimum

needs.
DOLLAR AMOUNT

Permanent current assets

TIME
 TEMPORARY WORKING CAPITAL
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The amount of current assets that varies with seasonal

requirements.

Temporary current assets

DOLLAR AMOUNT

Permanent current assets

TIME
 DISTINCTION –
PERMANENT AND TEMPORARY/VAIABLE
WORKING CAPITAL
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 Permanent is stable over time whereas variable is fluctuating

according to seasonal demands.
 Investment in permanent portion can be predicted with some
profitability whereas investment in variable cannot be predicted easily.
 While permanent is minimum investment in various current assets ,
variable is expected to take care for peak in business activity.
 While permanent component reflects the need for a certain
irreducible level of current assets on a continuous and uninterrupted
basis , the temporary portion is needed to meet seasonal & other
temporary requirements.
 Also permanent capital requirements should be financed from long -
term sources , short – term funds should be used to finance
temporary working capital needs of a firm.
 WORKING CAPITAL AND
FUNDING REQUIREMENTS
36

 Spontaneous Financing
 Firm will also always have minimum level of Accounts Payable—in
effect, money you have borrowed
 Accounts Payable (and Accruals) are generated spontaneously
 Arise automatically with inventory and expenses
 Offset the funding required to support current assets
 DECISION REGARDING
FINANCING OF CURRENT ASSETS:
37

Once the appropriate level of working capital is chosen,

the next decision pertains to determining the finance-mix
for current assets. Some of the sources that are used to
finance current assets are:
 Spontaneous liabilities

 Bank borrowings, Public deposits and long-term sources

of finance
 DECISION REGARDING
FINANCING OF CURRENT ASSETS:
38

 Spontaneous liabilities: Short-term liabilities such as sundry creditors,

accrued expenses, etc. and provisions that arise during the normal
course of business serve as non-interest bearing source of financing
current assets.

 Bank borrowings, Public deposits and long-term sources of finance :

The difference between the amounts of current assets and liabilities is
usually financed through a combination of bank borrowings by way of
cash credit/overdraft arrangement and long-term sources of finance
such as debentures and equity capital. Companies can also opt for
fixed deposits (obtained for a period of one to three years) for
financing current assets.
 WORKING CAPITAL FINANCING
POLICIES
39

 The financing policy opted by the firm can be classified

into three categories based on its risk attitude:
 Moderate: Match the maturity of the assets with the
maturity of the financing.
 Aggressive: Use short-term financing to finance
permanent assets.
 Conservative: Use permanent capital for permanent
assets and temporary assets.
 WORKING CAPITAL FINANCING POLICY:
MATURITY MATCHING PRINCIPLE
40

 Maturity (due date) of financing should roughly match duration

(life) of asset being financed.
 Then financing /asset combination becomes self-liquidating
 Cash inflows from asset can be used to pay off loan
 According to maturity matching principle
 Temporary (seasonal) should be financed with short-term borrowing
 Permanent working capital should be financed with long-term
sources, such as long-term debt and/or equity

 In practice, firms may use more or less short-term funds to

finance working capital.
 WORKING CAPITAL FINANCING POLICY:
MATURITY MATCHING PRINCIPLE
41
 SHORT-TERM VS.
42
LONG-TERM FINANCING
 The mix of short- or long-term working capital financing is a
matter of policy
 Use of long-term funds is a conservative policy
 Use of short-term funds is an aggressive policy
 SHORT-TERM VS.
43
LONG-TERM FINANCING
 Short-term financing
 Cheap but risky

 Cheap—short-term rates generally lower than long-term rates

 Risky—because you are continually entering marketplace to
borrow
 Borrower will face changing conditions (ex; higher interest
rates and tight money)
 SHORT-TERM VS.
LONG-TERM FINANCING
44

 Long-term financing
 Safe but expensive
 Safe—you can secure the required capital
 Expensive—long-term rates generally higher than short-term rates
 WORKING CAPITAL FINANCING POLICY:
CONSERVATIVE FINANCING POLICY
45

Use long-term sources like equity and debentures, for financing

current assets.
Will have a lower risk as there is a reduced probability of
“technical insolvency” that arises when a company is not in a
position to honor its current liabilities.
A conservative policy would imply a higher cost of financing since:
 Equity has the highest cost of capital and it does not have the
advantage of tax-deductibility that exists in the case of debt
capital.
 The interest on debentures has to be paid irrespective of the
fluctuating needs for financing current assets.
 WORKING CAPITAL FINANCING POLICY:
CONSERVATIVE FINANCING POLICY
46

Use more of bank borrowings and public deposits and less of long-
term sources of finance for financing its current assets.
Useful for companies that have a fluctuating need for current assets
because usually the bank borrowings are geared to move in tandem
with the fluctuating level of current assets so that the total interest
charge for the company is likely to be low.
An aggressive financing policy involves higher risk of “technical
insolvency.”
 Hence, depending upon the attitude of management towards risk
and keeping in view the constraints imposed by banking sector with
respect to short-term credit, the firm should choose the appropriate
financing policy.
 SUMMARY OF SHORT- TERM VS.
47
LONG-TERM FINANCING

Financing
Maturity
SHORT-TERM LONG-TERM
Asset
FINANCING FINANCING
Maturity

SHORT-TERM Moderate Low

(Temporary) Risk-Profitability Risk-Profitability

High
LONG-TERM Moderate
Risk-Profitability
(Permanent) Risk-Profitability
 STATIC VIEW OF WORKING CAPITAL

48

As per the static view, working capital can be defined in two
ways:
 Gross working capital: It is equal to the total current assets

(including loans and advances).

 Net working capital: It is the difference between current

assets and current liabilities (including provisions). It can be

also described as that part of a firm’s current assets which
is financed with the help of long-term funds.
 STATIC VIEW OF WORKING CAPITAL

49

Net working capital of a firm helps in comparing the liquidity

of the same firm over a period of time. (The liquidity of a firm
can be defined as the ability of the firm to satisfy short-term
obligations as they become due.)
The static view of working capital lays more emphasis on
the level of current assets compared to the level of current
liabilities.
 DRAWBACKS OF STATIC VIEW OF
WORKING CAPITAL
50

The static view of working capital has the following

drawbacks:
1. The working capital under this view is computed using the
data given in the balance sheet that is static in nature and
fails to reflect the dynamic nature of working capital that is
crucial in decision making .
2. The net working capital which is computed as the
difference between current assets and current liabilities
does not reflect the correct amount of working capital due
to the following reasons:
 DRAWBACKS OF STATIC VIEW OF
WORKING CAPITAL
51

 Short-term bank borrowings that are used for financing current

assets are shown separately under the heading of secured
loans and not as a part of current liabilities.
 Short-term Public deposits utilized for financing current assets

are shown under the category of unsecured loans and are not
included in current liabilities.
 Short-term marketable securities that are held for the purpose

of providing liquidity to the firm are shown under the heading of

investments and are not included in the current assets.
The reasons mentioned above lead to a miscalculation of the
amount of working capital.
 DYNAMIC VIEW OF WORKING CAPITAL
52

The dynamic view defines working capital is the amount

of capital required for the smooth and uninterrupted
functioning of the normal business operations of the firm.
Encompassing various activities such as
 Procurement of raw materials
 Conversion of raw materials into finished product for sale
 Creation of accounts receivable on account of goods sold on
credit
 Realization of profits from sales and cash from accounts
receivable
 ACTIVITIES OF
WORKING CAPITAL MANAGEMENT
53

Determination of the appropriate level of

1. Raw material inventory
2. Work-in-process inventory
3. Finished goods inventory
4. Determination of credit policies and credit period to be
extended to customers
5. Determination of the level of cash to be maintained by the
firm.
 THE OPERATING AND CASH CYCLES

 The operating and cash cycles indicate how effectively a

firm has managed its working capital.
 The shorter these two cycles are, the more efficient is the
firm’s working capital management.
 The operating cycle measures the time period that
elapses from the date that an item of inventory is
purchased until the firm collects the cash from its sale. If
an item is sold on credit, this date is when the accounts
receivable is collected.

54
 OPERATING/ WORKING CAPITAL CYCLE
55

 Operating cycle is the time duration required to convert sales, after

the conversion of resources into inventories, into cash. The
operating cycle of a manufacturing company involves three phases:
 Acquisition of resources such as raw material, labour, power and

fuel etc.
 Manufacture of the product which includes conversion of raw

material into work-in-progress into finished goods.

 Sale of the product either for cash or on credit. Credit sales

create account receivable for collection.

 OPERATING/ WORKING CAPITAL
CYCLE
56
 THE OPERATING CYCLE AND THE CASH CYCLE
57

Raw material
Cash
purchased Finished goods sold
received
Order Stock
Placed Arrives

Inventory period Accounts receivable period

Time
Accounts payable period

Firm receives invoice Cash paid for materials

Operating cycle
Cash cycle
ACTIVITIES OF WORKING CAPITAL MANAGEMENT
58

1. Determination of the appropriate level of raw material

inventory:
 A firm needs to decide the appropriate level of working capital by
keeping in view the following factors:

   Existence of raw materials in the domestic market.

   Need for importing the raw materials if not available indigenously
   Existence of restrictions imposed by government.
   The time lag between ordering and receiving of raw materials
   Discounts offered by suppliers.
   Price movements of raw materials in a period of high inflation
ACTIVITIES OF WORKING CAPITAL MANAGEMENT
59

1. Determination of the appropriate level of raw material

inventory:
 A firm needs to decide the appropriate level of working capital by
keeping in view the following factors:

   Existence of raw materials in the domestic market.

   Need for importing the raw materials if not available indigenously
   Existence of restrictions imposed by government.
   The time lag between ordering and receiving of raw materials
   Discounts offered by suppliers.
   Price movements of raw materials in a period of high inflation
ACTIVITIES OF WORKING CAPITAL MANAGEMENT
60

2. Determination of appropriate level of work-

in-process inventory:
 Depending on the nature of process technology used, the
firm should decide the required level of work-in-process
inventory.
 The level of work-in-process inventory will be higher in
case of firms where the raw material has to pass through
several stages during the process of production.
 ACTIVITIES OF
WORKING CAPITAL MANAGEMENT
61
3. Determination of appropriate level of finished goods
inventory:
Following factors help in determination of the required
amount of finished goods inventory:
 Degree of accuracy in forecasting sales demand.

 Ability to meet sudden spurt in demand.

 Seasonality of demand.

 Nature of finished goods: For example, if it is a perishable

good then lower inventory should be maintained.

 ACTIVITIES OF
WORKING CAPITAL MANAGEMENT
62
4. Determination of credit policies and credit period to be
extended to customers:
 The degree of competition in the industry
 General attitude of the competitors towards credit
 The credibility of the customer
 ACTIVITIES OF
WORKING CAPITAL MANAGEMENT
63

5. Determination of the level of cash to be maintained by the

firm:
 The required level of cash should be decided keeping in view

the following factors:

 Ability to meet cash payments
 Ability to avail sudden cash discounts offered by the suppliers
 Credit period extended to customers
 Credit period extended by suppliers
 Degree of synchronization between cash inflows and cash
outflows
 Minimum amount of cash to be maintained.
 WORKING CAPITAL/ OPERATING CYCLE
64 The time period between the purchase of raw materials and
the collection of cash for sales is referred to as operating
cycle. It consists of the following components:
 Raw Material Storage Period: The raw material storage period is
computed as:

where, Average stock of raw materials

=

and Average daily consumption of raw materials

=
 WORKING CAPITAL/ OPERATING CYCLE

Conversion Period
65  The average work-in-process inventory period can be
computed as: 

where, Average stock of work-in-process

=
Annual cost of production
= Opening stock of work-in-process + Annual consumption of raw
materials + Manufacturing costs such as wages and salaries, power
and fuel etc. + Depreciation –Closing work-in-process.
Average Daily cost of production
=
 WORKING CAPITAL/ OPERATING CYCLE

66 Finished Goods Storage Period

 Finished goods storage period
=
 Average stock of finished goods
=

Annual cost of sales

= Opening stock of finished goods
+ Annual cost of production
+ Excise Duty + Selling and Distribution costs
+ General administrative costs
– Closing stock of finished goods.
Average daily cost of sales =
 WORKING CAPITAL/ OPERATING CYCLE
67  Average Collection Period:

 Average Balance of Accounts Receivable

 Average daily credit sales of the company

=
 Average Payment Period:
68

 The average payment period is computed as:

 Average balance of sundry creditors

=

 Average daily credit purchases made by the company

= 
69
Computation of Operating Cycle: 

 Gross Operating Cycle

= Raw material storage period + Conversion period +
Finished goods storage period + Average collection
period 
 Net Operating Cycle

= Gross operating cycle – Average payment period

 CASH CONVERSION CYCLE
70
 A firm can minimize its working capital by speeding up
collection on sales, increasing inventory turns, and slowing
down the disbursement of cash.
 Cash Conversion cycle (CCC) captures the above.
 CCC = days of sales outstanding + days of sales in inventory
– days of payables outstanding.
 SHORTENING THE CASH
CONVERSION CYCLE
The firm’s goal should be to shorten its cash conversion
71

cycle as much as possible without hurting operations.
 The cash conversion cycle can be shortened
1. By reducing the inventory conversion period by processing
and selling goods more quickly.
2. By reducing the receivables collection period by speeding up
collections.
3. By lengthening the payables deferral period by slowing down
the firm’s own payments.
 To the extent that these actions can be taken without
increasing costs or depressing sales, they should be carried
out.
 ESTIMATING WORKING CAPITAL
72

 Current assets holding period

 To estimate working capital requirements on the basis of average
holding period of current assets and relating them to costs based
on the company’s experience in the previous years. This method
is essentially based on the operating cycle concept.
 Ratio of sales
 To estimate working capital requirements as a ratio of sales on
the assumption that current assets change with sales.
 Ratio of fixed investment
 To estimate working capital requirements as a percentage of
fixed investment.