Working Capital Planning

Q1. While preparing a project report on behalf of a client you have collected the following facts. Estimate the
net working capital required for that project. Add 10% to your computed figure to allow contingencies:

Particulars Amount per unit

Estimated cost per unit of production
Raw material Rs 80
Direct Labour 30
Overheads 60
Total cash cost 170
Additional information
Selling Price Rs 220 per unit
Level of activity 1,04,000 units of production p.a
Raw material in stock, average 4 weeks
Work in progress (assume 50 % completion stage in respect of conversion costs and 100 % completion in
respect of materials), average 2 weeks
Finished goods in stock, average 4 weeks
Credit allowed by suppliers, average 4 weeks
Credit allowed to debtors, average 8 weeks
Lag in payment of wages, average 1.5 weeks
Cash at bank is expected to be Rs 25,000

You may assume that production is carried on evenly throughout the year ( 52 weeks ) and wages and
overheads accrue evenly similarly. All sales are on credit basis only.

Q2. X & Y are desirous to purchase a business and you are asked to advise the average amount of working
capital which will be required in the first year’s working from the following estimates. Also add 10 % to your
computed figure to allow for contingencies.

i. Average amount backed by stocks:

Stock of finished product Rs 5,000
Stock of stores and materials Rs 8,000
ii. Average credit given:
Inland sales 6 weeks credit Rs 3,12,000
Export sales 1.5 weeks credit Rs 78,000
iii. Average time lag in payment of wages and other outgoings:
Wages, 1.5 weeks Rs 2,60,000
Stocks and materials, 1.5 months Rs 48,000
Rent and Royalties, 6 months Rs 10,000
Clerical staff, 0.5 month Rs 62,400
Manager, 0.5 month Rs 4,800
Miscellaneous Expenses, 1.5 month Rs 48,000
iv. Payment in advance:
Sundry expenses (paid quarterly in advance) Rs 8,000
Undrawn profits on an average throughout the year Rs 11,000
Q3. A newly formed company has applied for a loan to a commercial bank for financing its working capital
requirements. You are requested by the bank to prepare an estimate of the requirements of the working capital
for the company. Add 10% to your estimated figure to cover unforeseen contingencies. The information about
the projected profit and loss account of this company is as under:

Sales Rs 21,00,000
Cost of Goods Sold Rs 15,30,000
Gross Profit Rs 5,70,000
Administrative Expenses Rs 1,40,000
Selling Expenses Rs 1,30,000 Rs 2,70,000
Profit Before Tax Rs 3,00,000
Provision for tax Rs 1,00,000

Note: Cost of Goods Sold has been derived as follows:

Material used Rs 8,40,000

Wages and Manufacturing Expenses Rs 6,25,000
Depreciation Rs 2,35,000
Rs 17,00,000
Less: stock of Finished Goods ( 10% not yet sold) Rs 1,70,000
Rs 15,30,000

The figures above relate only to the goods that have been finished and not work in progress; goods equal to 15%
of the year’s production (in terms of physical units) are in progress on a average, requiring full materials but
only 40% of other expenses. The company believes in keeping two months consumption of materials in stock,
desired cash balance Rs 40,000.

Average time lag in payment of all expenses is 1 month; suppliers of materials extend 1.5 months credit; sales
are for 20% cash; rest are at two months credit; 70% of the income tax has to be paid in advance in quarterly
instalments.

You can make any other assumptions as you deem necessary for estimating working capital requirements.
How to Calculate Operating Cycle using Formula?

The time of operating cycle can be broken as follows:

1. Inventory Holding Period

• Raw Material Holding Period
• Work-in-process Period
• Finished Goods Holding Period

2. Receivables Collection Period

Formula for Operating Cycle

Operating Cycle = Inventory Holding Period + Receivable Collection Period

Or,

Operating Cycle = Raw Material Holding Period + Work-in-process Period + Finished Goods Holding Period +
Receivable Collection Period

Formula for Cash Operating Cycle

Cash Operating Cycle = Inventory Holding Period + Receivable Collection Period – Creditor’s Payment Period
Or, Cash Operating Cycle = Raw Material Holding Period + Work-in-process Period
+ Finished Goods Holding Period + Receivable Collection Period – Creditor’s Payment Period

Operating Cycle Example

Suppose $500 Dollar worth of inventory is purchased from a supplier on 20 days credit and it was sold after 40
days of purchasing it. The credit of 40 days is given to the buyer. The buyer paid on completion of the credit
period.

Here,

The Operating Cycle = Inventory Holding Period + Receivable Collection Period

= 40 + 40 = 80 Days.
Cash Operating Cycle = 80 Days – 20 Days (Supplier’s Credit) = 60 Days.