Estimation of Working Capital

Estimation of Working Capital
1. Introduction
The funds required by every business organization can broadly classify into fixed capital and Working Capital. Fixed capital is needed for the acquisition of fixed asset. Fixed assets constitute of basic tools of the means of production. Investment in fixed assets by itself is dead investment and the funds so locked up do not circulate continuously. Every business organization requires some funds to carry on its operations and to produce goods for sale to earn profit. These funds which are represented by the current capital used through the various steps of production and distribution and are invested in Current Asset. There are two concepts of working capital viz. quantitative and qualitative. Some people also define the two concepts as gross concept and net concept. According to quantitative concept, the amount of working capital refers to total of current assets. What we call current assets? Smith called, circulating capital. Current assets are considered to be gross working capital in this concept. The qualitative concept gives an idea regarding source of financing capital. According to qualitative concept the amount of working capital refers to excess of current assets over current liabilities. L.J. Guthmann defined working capital as the portion of a firms current assets which are financed from longterm funds. The excess of current assets over current liabilities is termed as Net working capital. Concept Net working capital represents the amount of current assets which would remain if all current liabilities were paid. Both the concepts of working capital have their own points of importance. If the objectives is to measure the size and extent to which current assets are being used, Gross concept is useful; whereas in evaluating the liquidity position of an undertaking Net concept becomes pertinent and preferable.
Definition: Difference between the book value of the Current Assets and the Current Liabilities. By Hoagland
The management of Working Capital is by no means an easy task but presents stimulating challenges to the financial executive. It requires his constant attention and exercise of skill and judgment through knowledge of business on awareness of economic trends and familiarity with the money market. For smooth running an enterprise, adequate amount of working capital is very essential. Efficiency in this area can help, to utilize fixed assets gainfully, to assure the firms long term success and to achieve the overall goal of maximization of the shareholders, fund. Shortage or bad management of cash may result in loss of cash discount and loss of reputation due to non-payment of obligation on due dates. Insufficient inventories may be the main cause of production held up and it may compel the enterprises to purchase raw materials at unfavorable rates. Working capital has acquired a great significance and sound position in the recent past for the twin objects of profitability and liquidity. In period of rising capital costs and scare funds, the working capital is one of the most important areas requiring management review. It is rightly observed that, Constant management review is required to maintain appropriate levels in the various working capital accounts. Mainly the success of a concern depends upon proper management of working capital so working capital management has been looked upon as the driving seat of financial manager. It consumes a great deal of time to increase profitability as well as to maintain proper liquidity at minimum risk. There are many aspects of working capital management which make it an important function of the finance manager. In fact we need to know when to look for working capital funds, how to use them and how measure, plan and control them.
2. Types of Working Capital

Working Capital is divided into various types based balance sheet view and operating cycle view. Balance sheet view divides working capital into gross working capital and net working capital and the operating cycle view divides the working capital into permanent and temporary working capital. Permanent working capital is further divided into seasonal and special working capital whereas temporary working capital into regular and reserve working capital. Working capital is the capital / funds required for day to day operations of the business. Working capital is invested usually in all types of inventories such as raw materials, spares, finished goods etc. and credit extension to debtors and cash in hand.
Types of Working Capital:

Working capital is classified into different types and the classification is based on the following views: 1. Balance Sheet View 2. Operating Cycle View
On the basis of Balance Sheet View, types of working capital are described below:
Gross Working Capital (GWC): Current assets in the balance sheet of a company are known as gross working capital. Current assets are those short term assets which can be converted into cash within a period of one year. The grey area in the management of current assets or gross working capital is its unpredictability i.e. it is very difficult to ascertain the exact time
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of conversion of such assets. Why such a nature is problematic? It is because the liabilities occur at their time and do not wait for our current asset to realize. This mismatch or the gap creates a need for arranging working capital financing. Net Working Capital (NWC): Net working capital is a very frequently used term. There are two ways to understand net working capital. First one says it is simply the difference of current assets and the current liabilities in the balance sheet of a business. The other understanding discloses little deeper or hidden meaning of the term. As per that, NWC is that part of current assets which are indirectly financed by long term assets. Compared to gross working capital, net working capital is considered more relevant for effective working capital financing and management.
On the basis of Operating Cycle View, types of working capital are as below:
Permanent / Fixed Working Capital: Dealing with current asset and fixed assets is totally different. Determining the financing requirement in case of fixed assets is simply the cost of the asset. Same is not true for current assets because value of current assets is constantly changing and it is difficult to accurately forecast that value at any point of time. To simplify the complexity to some extent, on the basis of past trend and experience, we can find a level below which current asset has never gone. Temporary / Variable WC: Temporary working capital is easy to understand after getting hold over permanent working capital. In simple terms, it is the difference between net working capital and permanent working capital. The main characteristic which can be made out from the
example is fluctuation. The temporary working capital therefore cannot be forecasted. In the interest of measurability, this can be further bifurcated as below which can create at least some base to forecast. a) Seasonal Working Capital: Seasonal working capital is that temporary increase in working capital which is caused due to some relevant season for the business. It is applicable to businesses having impact of seasons for example, manufacturer of sweaters for whom relevant season is the winters. Normally, their working capital requirement would increase in that season due to higher sales in that period and then go down as collection from debtors is more than sales. b) Special Working Capital: Special working capital is that rise in temporary working capital which occurs due to a special event which otherwise normally does not take place. It has no basis to forecast and has rare occurrence normally. For example, country where Olympic Games are held, all the business require extra working capital due to sudden rise in business activity.
3. Working Capital Estimation

Particular Particular Rs. in lakhs Particular Base Rs. % in lakhs 52.48 10.01 2013 2014 Rs. Rs. in lakhs in lakhs 10529 2008 12537 12635 2410 15044
Direct raw material consumed Direct wages Direct Expenses PRIME COST ADD:- factory Overheads Consumption of Stores And Spares Repairs and Maintenance Building Depreciation on plant & machinery Depreciation on building packing expenses freight and handling expenses Repairs and Maintenance - Plant & Machinery Power and Fuel WORK COST ADD:- Administration overheads Rent Auditors Remuneration Repairs and Maintenance other job work expenses director's sitting fees postage , telegrams and telephones Insurance Rates & Taxes Other Expenses COST OF PRODUCTION Add: selling & Distribution Expenses bad debts written off discount on sale provision for doubtful debts Research & development expenses
105 15 324 219 202 166 225 1913
126 18 389 263 242 199 270 2296
0.63 0.09 1.94 1.31 1.21 0.99 1.35 11.44 3169 15706 3803 18847
82 23 23 50 2 24 42 43 635
82 23 23 50 2 24 42 43 635
0.41 0.11 0.11 0.25 0.01 0.12 0.21 0.21 3.17
924 16630
924 19771
14 19 486 20
6
17 23 583 24
0.08 0.11 2.91 0.12
marketing and promotional expenses commission on sales provision for doubtful advances Traveling &conveyance COST OF GOODS SOLD PROFIT SALES
496 559 269 246
595 671 323 295
2.97 3.34 1.61 1.47 2109 18739 6.59 100% 1322 20061 295 20066 4006.8 24073
Working Note1: Sales FOR 2013 On Assumption Basis (increase by 20%) 20061 24073
Working Note2: 1) Raw Materials: Raw Materials = Closing Stock of Raw Material
X 365
Raw Material Consumed = 1429

X 365
10529 = 50 days
2) Work in Progress: Work in Progress = Closing Stock of Work in Progress

X 365
Cost of Production = 763

X 365
16630 = 17 days
3) Finished Goods: Finished Goods = Closing Stock of Finished Goods

X 365
Cost of Goods Sold = 1496

X 365
18739 = 29 days
4) Traded Goods: a) Traded Goods Consumed = Opening Stock + Purchase Closing Stock = 85 + 254 102 = 237
b) Traded Goods
= Closing Stock of Traded Goods

X 365
Traded Goods Consumed = 102

X 365
237 = 157 days
5) Trade Receivable: a) O/s More than 6 months = Closing Trade Receivable

X 365
Net Sales = 6687 20061 = 122 days

X 365
b) Other Outstanding =
Closing Trade Receivable

X 365
Net Sales
8
10930 20061
X 365
= 122 days
6) Cash & Bank Balance: Assuming that closing Balance of 2013 is to remain constant for all month
Cash & Bank Balance
Cash No. of months
819 12
= Rs. 68
7) Trade Payable: Trade Payables = Creditors

X 365
Credit Purchase = 6388

X 365
10529 = 221 days
8) Payables for Fixed Assets:* Payables for Fixed Assets = 434 12 = Rs. 36.17
9) Current maturities of long term borrowing:* Current maturities of long term borrowing = 4407 12 = Rs. 367.25
10) Interest accrued but not due on borrowing:* Interest accrued but not due on borrowing = 46 12 = Rs. 3.83
11) Interest accrued and due on borrowing:* Interest accrued and due on borrowing = 275 12 = Rs. 22.92
12) Due to subsidiaries:* Due to subsidiaries = 1066 12 = Rs. 88.83
13) Employee related liabilities:* Employee related liabilities = 442 12 = Rs. 36.83
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14) Interest bearing securities:* Interest bearing securities = 237 12 = Rs. 19.75
15) Advance from customers:* Advance from customers = 665 12 = Rs. 55.42
16) Investor education and protection fund:* Investor education and protection fund = 31 12 = Rs. 2.58
17) Other liabilities:* Other liabilities = 309 12 = Rs. 25.75
Note: * Assumed it remains constant.
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PARTICULAR CURRENT ASSETS Stock -in trade Raw Material Work in progress Finished goods Traded goods Trade receivable more then 6 month other trade receivable Cash and bank balance Total (A) CURRENT LIABILITIES Trade payable Payable on fixed assets Current maturities of long term borrowing Interest Accrued but not due on borrowing Interest accrued and due on borrowing Due to subsidiaries Employees related liabilities Interest bearing securities Advance from customers Investor education and protection fund Other liabilities Total (B) NET WORKING CAPITAL
period
calculation
amount
50 days 17 days 29 days 122 days 122 days 199 days 1 month
1429*50/365 763*17/365 1496*29/365 102*157/365 6687*122/365=2235.11 10930*199/365=5959.10
195.75342 35.54 119.43 43.90
8194.20 68 8657.07
221 days 1 month 1 month 1 month 1 month 1 month 1 month 1 month 1 month 1 month 1 month
6388*221/365
3867.80 36.17 367.25 3.83 22.92 88.83 36.83 19.75 55.42 2.58 25.75 4527.14
(A) (B)
4129.94
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Estimation of Working Capital

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