Working Capital Management

Unit 5
Financial Management
MBA 2nd Semester
Department of Business
Administration, University of
Lucknow, Lucknow

1
Working Capital Management
Working capital management is a business
strategy to ensure that operating activities of
business are smooth and efficient. Working
capital management involves a relationship
between current assets and current liabilities
enabling the company to maintain adequate
working capital in order to meet the current
obligations of business.
Two Concepts of Working Capital:
Gross Working Capital = Total Current Assets
Net Working Capital =Current Assets – Current
Liabilities
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Current Assets and Current Liabilities
Current assets mean those short term assets which in the normal course of business
are converted into cash within a year. Examples of current assets are:
1. Inventories of raw material, work-in-progress and finished goods
2. Debtors, bill receivable
3. Short term investment or marketable securities
4. Pre-paid expenses
5. Short term advances
6. Accrued incomes
7. Cash in hand and bank balances
Current liabilities are those short term liabilities which in the normal course of
business are payable within a year. Examples of current liabilities are:
1. Creditors, bill payables
2. Outstanding expenses
3. Short term loans
4. Bank overdrafts
5. Provision for tax
6. Proposed dividends etc.
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Different Sources of Working Capital
A business firm uses two types of sources to finance its working
capital requirements:
A. Long Term Sources
B. Short Term Sources
Long Term Sources of Working Capital Financing:
Every business is required to maintain a minimum balance of
cash and other current assets at all times irrespective of business
level of operations. The part of working capital which is
continuously maintained by any business at all times to carry on
its business is called the permanent working capital. This type of
working is advised to be financed partly through long term
sources as given under:
1. Issue of equity and preference share capital
2. Retained earnings
3. Issue of debentures and long term bonds
4. Long term loans from financial institutions
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Short Term Sources of Working Capital Financing:
Generally, it is the short term working capital which used
to finance the short term payment obligations. This
working capital is termed as temporary working capital
needed to support seasonal fluctuations in the operations.
The examples of short term sources are given as under:
1. Bank credit, overdraft etc.
2. Public deposits
3. Trade credits
4. Sales revenues
5. Outstanding expenses
6. Provision for depreciation, taxes etc
7. Advances from customers
8. Employees’ security money etc.
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Importance of Working Capital Management
1. Efficient and smooth business operations
2. Optimizing profits in current assets investment
3. Helpful in continuous production and supply
4. Improved liquidity and solvency of business
5. Enhancement in business credibility
6. Efficient use of fixed assets
7. Meeting of contingencies
8. Timely payment of interest and dividend
9. Better cash flow management
10. Consistent with wealth maximization objective
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Consequences of Inadequate and Surplus of Working Capital
Working capital management seeks to find the optimum
level to ensure liquidity and maximize profitability. The
working capital of an organization is the result of deducting
its current liabilities. If managers do not keep an
organization's working capital within certain levels, it can
have serious consequences to the organization's financial
health.
The Inadequacy of working capital results in the following:
1. Interrupted production and supply
2. Low employees morale
3. Low efficiency and profitability
4. Low market reputation
5. Defaults in payment of interest and other dues
6. Lack of synchronization in cash flows
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Consequences of Excess Working Capital
On the other hand surplus working capital is also not good
for the organization. Excess working capital in a business
organization results in the following consequences:
1. Wastage and quality deterioration of inventory
2. Increased cost of funds invested in working capital
3. Unnecessary expenses leading to inefficiency and losses
4. Misuse of resources
5. Increased bad debts and defaults
6. Increased imbalance in cash flows
7. Continuous fall in efficiency and profitability

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Concept of Optimum Level of Working Capital
Optimum level of working capital is that level of
working capital where the business organization is
capable to pay all its short term dues.
In addition to this, the company should carry an
additional working capital in order to meet its
emergency situation of business such as delay in
supply of raw material, sudden excess demand of
production and supply, payment of advance to
suppliers, employees etc.
Optimum level of working capital is the situation
wherein the cost of liquidity and the cost of
illiquidity both are balanced at an intersection point
as both of these costs are inversely related.
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Important Principles of WC Management
Principles of working capital management are the
general guidelines which if are carefully followed
would lead to effective and efficient management of
working capital in a given organization. These
principles are:
1. Principle of Equity Position of Current Assets
2. Principle of Cost of Capital
3. Principle of Maturity of Payment
4. Principle of Risk Variation

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 Principles of WC Management (Cont..)
Principle of equity position: As per this principle all the current assets in the
organization should measured optimally so that each part of current asset can
contribute to the net worth of the firm. The position of current assets can be
well judged by the two ratios: a) current assets to total asset and; b) current
asset to total sales.
Principle of Cost of Capital and Risk: Different sources of working capital
finance have different cost of capital. There is an inverse relationship between
the risk and cost of capital, which means more the risk less will be the cost and
vice versa. So there should be balance between the two, cost and risk. For
example loan is less costly and more risky whereas reserve is more costly and
less risky.
Principle of Maturity of Payment: This principle states that funds for
working capital should be raised from different sources keeping in mind their
maturity aspect so that the firm can repay them on the time of their maturity of
payment.
Principle of risk variation: there is direct relationship between risk and
return. More liquidity facilitates transaction and reduces the risk of failure of
operation but high funds means more cost of capital and less return and vice
versa.

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Factors affecting Working Capital Requirement
1. Length of operating and manufacturing cycle
2. Nature of business
3. Scale of operation
4. Business cycle fluctuation
5. Seasonal factors
6. Production techniques
7. Sales and credit policy
8. Credit availability
9. Operating efficiency
10. Easy availability of raw material
11. Level of competition
12. Level of inflation
13. Growth prospects of business
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Operating and Manufacturing Cycle

13
Nature of Business

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Scale of Business Operation

15
Business Cycle Fluctuations

16
Seasonal Factors

17
Production Techniques

18
Sales and Credit Policy

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Concluding Remarks
1. Working capital management establishes a relationship between
current assets and current liabilities.
2. The objective of working capital management is to ensure
smooth functioning of business operation and timely meeting
short term obligations.
3. In order to fulfill working capital management objectives,
finance manager is required to ensure the availability of
optimum working in business.
4. Optimum working capital is that position which is none of
shortage or excess of working capital.
5. Only at optimum working capital business ensures efficiency
and profitability in working capital management.
6. The four principles of working capital management are helpful
in fulfilling the objectives.
7. there are a number of consideration that influence working
requirement in an organization.

20
 Receivable Management
Unit 5th
Financial Management
MBA 2nd Semester

Department of Business Administration,

University of Lucknow

1
Receivables Management
Meaning
Accounts receivable management is the process of making
credit sales and ensuring that resulting debtors pay their
dues on time. It helps the business to prevent itself from bad
debt losses and running out of cash at any point of time. It
strengthens the profitability and liquidity position.
Objective of Receivable Management
1. To Ensure an optimum level of receivables
2. To minimize bad debt losses
3. To maintain proper records of receivables
4. To boost up the sales volume
5. To Improve customer satisfaction
6. To face competition
7. To meet industry requirement

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How to Ensure Optimum Level of Receivables

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Process of Accounts Receivable Management
An Account receivable management process
involves the following:
1. Analysis of paying ability of the customers
2. Extending credit sales to them.
3. Monitoring any risk of non-payment or delay in
receiving the payments.
4. Maintaining good Customer relations
5. Addressing the complaints of the customers.
6. Keeping proper records
7. Recovering payments
8. Preventing any bad debts
9. Analyzing the process

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Significance of Receivables Management
1. Cash flow management
2. Sales optimization
3. Profit planning
4. Cost control and bad debts minimization
5. Business growth
6. Good customers relations
7. Good suppliers relations
8. Meeting industry requirement

5
Benefits of Receivables Management
1. Better Cash Flow.
2. To manage our operations and expansion plans.
3. Lower Working Capital Requirements.
4. Lowered Interest cost
5. Optimum debtors minimizes bad debt losses.
6. Better Bargaining with Sellers.
7. To bargain effectively with Suppliers.
8. Stop profit leakages
9. Sales and profit management

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 Basic Issues involved in Receivable Management
1. Getting paid within the agreed upon terms.
2. Actually getting paid or receiving empty promises from
customers.
3. How to maintain good customer relations with late paying
customers.
4. Having enough time to manage the collections process.
5. Actually reaching customers when trying to follow up.
6. Dealing with credit approvals and offering lines of credit.
7. Collecting from customers that appear to be failing.
8. Resolving payment disputes.
A solid credit collection strategy can help solve many of the above
problems in a relatively short period of time, but having the right
policy in place is crucial.
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Components of Credit Policy
1. Credit eligibility standards.
It means the type of customers to whom we can offer credit
sales.
2. Credit terms
It means period of credit and discounts on early payment
etc.
3 Clear documentation.
All the customers which are extended credit sales should be
properly documented so that a proper monitoring can be
possible.
4. Collections efforts or follow up
The customers which have been provided credit sales should
be approached timely to recover dues from them otherwise
these customers would delay payment and may result into
bad debts.
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(a) Debtors Turnover Ratio:

(b) Average Credit Period (in days):

(c) Debtors to Current Assets Debtors:

(d) Debtors to Total Assets Debtors:

(e) Bad Debts to Sales:

(f) Bad Debts to Debtors:

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Factoring Services

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Services provided by the factor
1. Finance
2. Collection of debts
3. Maintenance of debts
4. Protection of Credit Risk
5. Maintenance of debtors ledger
6. Debtors follow-up
7. Advisory services
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Advantages and Disadvantages of Factoring

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Numerical on credit policy
ABC Ltd. is making a sales of ₹16,00,000 and it extends a credit of 90
days. However, in order to overcome the financial difficulties, it is
considering to change the credit policy. The proposed terms of credit
and expected sales are given as under:
Policy Proposed Terms Expected Sales (₹)
1 75 days 15,00,000
2 60 days 14,50,000
3 45 days 14,25,000
4 30 days 13,50,000
5 15 days 13,00,000
The firm has a variable cost of 80% and fixed cost of ₹ 1,00,000. The
cost of capital is 15%. Evaluate different proposed policies and advice
which policy is the most beneficial. A year may be assumed to have
360 days.
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Solution:
Present Proposed Policies
Policy Policy-1 Policy-2 Policy-3 Policy-4 Policy-5
(90 days) (75 days) (60 days) (45 days) (30 days) (15 days)
Sales (₹) 16,00,000 15,00,000 14,50,000 14,25,000 13,50,000 13,00,000

Less VC @ 80% 12,80,000 12,00,000 11,60,000 11,40,000 10,80,000 10,40,000

Less FC 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000

Profit (A) 2,20,000 2,00,000 1,90,000 1,85,000 1,70,000 1,60,000

Total cost (VC+FC) 13,80,000 13,00,000 12,60,000 12,40,000 11,80,000 11,40,000

Average Receivables at 3,45,000 2,70,833 2,10,000 1,55,000 98,333 47,500

cost (total cost x credit
period /360)
Cost of debtors @15% 51,750 40,625 31,500 23,250 14,750 7,125
(B)
Net Profit (A-B) 1,68,250 1,59,375 1,58,500 1,61,750 1,55,250 1,52,875
Conclusion: As we see, after a change in present credit policy, the maximum benefit is available
in policy-3 (₹ 161,750), hence, policy-3 is the most beneficial and can be adopted.
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Concluding Remarks
1. Receivables management simply means credit sales management.
2. While managing receivables the manager ensures optimum level of
receivables.
3. Optimacy of receivables comes when there is trade off between the
liquidity and profitability.
4. Both of the liquidity and profitability are affected by level of credit sales.
5. Benefits of credit sales are increase in sales and profits of organization.
6. If sales are offered without a proper policy then losses of bad debts on
account of defaults of payment from debtors are more.
7. If sales are restricted from the fear of bad debt losses then sales and
profits both are low.
8. In order to take the proper benefit of credit sales a proper credit policy
needs to be formulated.
9. In a proper credit policy considerations are given on the four aspects:
credit standards, credit terms, proper documentation and collection
efforts.
10. Factoring services are of great help in the management of receivables.
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 Cash Management
Unit 5th
Financial Management
MBA 2nd Semester

Department of Business Administration,

University of Lucknow,
Lucknow

1
Cash Management
Meaning
Cash management is the process of collecting and managing
cash flows. In business, it is a key component of a company's
financial efficiency, profitability, survival, stability and
growth.
Objectives of Cash Management
The objectives of cash management are:
1. Cash Planning and preparation of cash budget
2. Reducing cash management expenses
3. Meeting short term cash payment obligations
4. Timely collecting cash from debtors
5. Availing cash payment discounts
6. Synchronization of cash flows
7. Determination of minimum and optimum cash balances
8. Investment in marketable securities
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 Cash management process
The process of cash management is shown in the figure below:

Cash Collection and Cash Payments:

Cash management of a business should reduce the cash collection period and lengthen
cash payments.
Optimal Cash Balance and Marketable Securities
It helps reduce the optimal cash balance and therefore reduce the opportunity cost of
holding it.
Excess or idle cash should be invested in short-term marketable securities, which are
often called short-term investments in a balance sheet. In the process of selecting
marketable securities, we should take into account the following:
1. Maturity
2. Liquidity and marketability
3. Default Risk in Investment
4. Return/yield

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Optimum Level of Cash as per Baumol’s Model

Cost of holding Cash:

This is the combined cost of fund used in business also known as opportunity cost of capital and
the transaction cost. When this cost is minimized the optimum cash balance is achieved.
Opportunity cost:
This is cost of capital payable for using cash to the investors or provider of this cash.
Transaction cost:
This is the cost of converting the marketable securities into cash and vice versa
Optimal level of Cash
This level of cash is achieved when opportunity cost and transaction costs cut each other because
both of these costs are inversely related. The combination of these two costs gives us the cost of
holding cash. At the minimum point of this cost also the optimum cash level is achieved.
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Optimum Cash Balance as per Baumol’s Model

Baumol’s model of optimum cash balance is same as EOQ model of

inventory management and can be presented as follows:
C = √2FT/r
Where,
C= Cash required to restore as optimum cash balance
F= Total cash required during the year
T= Transaction cost between cash and marketable securities
r= Opportunity cost of capital used in maintaining cash balance
Average Cash Balance = C/2
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Computing Optimum Cash Balance
Question 1
A firm has total cash requirement of ₹ 5,00,000 per
annum. Its rate of interest (opportunity cost) is 15%
and on each transaction between cash and marketable
securities it has to pay ₹25. Compute the optimum
cash balance the firm requires each time and the
average cash it maintains throughout the year.
Solution:
Optimum Cash Required by the firm:
C = √2FT/r =√2x25x5,00,000/0.15
= ₹12,910 (Answer)
Average cash maintained by the firm:
C/2 = 12,910/2= ₹6,455 (Answer)
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Importance of cash management
1. Credibility of business
2. Efficiency, profitability and survival
3. Adequacy of cash
4. Minimization of costs and bad debts
5. Provision for contingencies
6. Meeting cash obligations
7. Satisfaction for stakeholders
8. Fulfillment of wealth maximization
objective
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Important Functions under Cash Management
1. Synchronization of cash flows
2. Faster stock out to ensure movement of cash and
liquidity
3. Faster recovery from receivable or debtors
4. Payables or creditors management
5. Forecasting for sales and contingencies
6. Preparation of cash budget
7. Short term investment in securities
8. Other functions e.g. monitoring bank account,
managing e-banking, pooling and netting of
assets, maintaining good relations with suppliers
and customers for enhancing cash liquidity.
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Limitations of Cash Management
1. Cash management is a continuous activity.
2. Cash management requires knowledge of money
market.
3. Cash management and working capital management
need to be distinguished.
4. Cash planning and cash budgeting requires an
expertise on the part of managers.
5. Compliance of banking and money market norms.
6. Need for efficient credit policy.
7. Need for efficient policy of inventory management.
8. More focus on cash from operations
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Important Techniques of Cash Management
Techniques of cash management are all those tools and
techniques relating to cash flow management. Some
important tools and techniques are discussed below:
1. Cash flow management
2. Float management
3. E-banking transactions,
4. National Electronic Funds Transfer (NEFT)
5. Concentration banking, decentralized billing and collection
6. Lock box system
7. Centralized disbursements
8. Account payee and distant bank payment
9. Availing the grace period
10. Avoiding early payments
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 Inventory Management
Unit 5th
MBA, 2nd Semester

Department of Business Administration,

University of Lucknow,
Lucknow

1
Inventory Management
Definition:
Inventory management is an approach for keeping track of the flow of
inventory. It starts right from the procurement of goods and its
warehousing and continues to the outflow of the raw material or stock to
reach the manufacturing units or to the market, respectively. The process
can be carried out manually or by using an automated system.
Objectives of inventory management:
1. To maintain inventory at appropriate level
2. To avoid excessive or shortage of inventory because both the cases
are undesirable for business.
3. To ensure that the supply of raw material & finished goods will
remain continuous so that production process is not halted and
demands of customers are duly met.
4. To minimize carrying cost of inventory.
5. To keep investment in inventory at optimum level.
6. To reduce the losses of theft, obsolescence & wastage etc.
7. To make arrangement for sale of slow moving items.
8. To minimize inventory ordering costs.
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Importance/Benefits of inventory management
1. Reduces costs, improves cash flow, optimizes profits
2. Keeps track of inventory in real time
3. Helps forecast demand
4. Prevents product and production shortages
5. Prevent excess stock and too many raw materials
6. Allow for easy inventory analysis
7. Meeting the requirement of fluctuation in demand and
production
8. Optimize warehouse organization and precious
employee time
9. Offer quick and easy bar code scanning to speed up
intake
10. Multi location management

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4
ABC Analysis Curve

5
ABC Analysis (cont..)

6
Numerical on ABC Analysis

7
Solution:

8
Optimum level of Inventory to order

9
Example of EOQ:

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Setting of various stock levels

11
Review of slow and non moving items

12
Inventory Control Ratios

13
Perpetual inventory and stock verification

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Concluding Remarks
1. Inventory management means to keep track the flow of inventory in an organization.
2. The objective of inventory management is to ensure an optimum availability of
inventory for smooth production and market supply.
3. Optimum level of inventory is in between the excess level and insufficient level of
inventory.
4. At an optimum level of inventory the total average cost is minimum.
5. There are various techniques for inventory management and control such as ABC
Analysis, Economic Order Quantity (EOQ), just in time(JIT) deciding various levels
of inventory, review of slow moving and non moving items etc.
6. ABC Analysis is a selective inventory control in which the entire inventory is divided
into three different categories and then control is applied depending upon the cost and
quantity of these inventories.
7. In EOQ the optimum size of inventory is computed for the purpose of purchase of
inventory from the market.
8. Several other techniques of inventory management and control can used depending
upon the severity of requirement.
9. Inventory management is the most crucial for manufacturing and trading concerns
and no so crucial for service concerns.
10. Effective inventory management contributes in the overall working capital
management, efficiency and profitability of concern as inventory is a component of
working capital. The other two components are cash and receivables.

15
Estimating Working Capital Requirement
Operating Cycle Method:
This method of estimating working capital
requirements is based upon the operating cycle
concept of working capital. The cycle starts with
the purchase of raw material and other resources
and ends with the realization of cash from the
sale of finished goods after cash and credit sales.
For proper computation of working capital under
this method, a detailed analysis is made for each
individual component of working capital i.e.
current asset and current liabilities.
1
Operating and Manufacturing Cycle

2
Statement of Working Capital Requirement
Estimation of Current Assets and Current Liabilities Amount (₹)
Current Assets:
Stocks of raw material, work in process & finished goods

Debtors/Receivables
Cash
Others
Less: Current Liabilities
Creditors Bills payable
Outstanding expenses
others
Working Capital (CA-CL)
Add: Provision/Margin for contingencies

Net Working Capital Required

3
Computing the Value of Items of CA and CL
The value of each individual item of current assets and current
liabilities is determined on the basis of estimated sales or
budgeted production or activity level as follows:
Estimating the values of Current Assets
(a) Stock of Raw Material:
The amount of working capital funds to be invested in holding
stock of raw material can be estimated on the basis of budgeted
units of production, estimated cost of raw material per unit and
the average duration for which the raw material is held in stock
by using the following formula:
Estimated value of Stock of Raw Material=
Budgeted Units of Production x Cost per unit x Average holding
period in months or weeks or days/No. of months or weeks or
day in a year
4
Question on estimating the value of Stock of Raw Material
Question 1
You are given the following information regarding the stock of raw
material:
1. Proposed level of activity of production and sale is 1,44,000 units.
2. Cost per unit of raw material is ₹45.
3. Raw materials are expected to remain in stock for a period of two
months.
Required:
Estimate the working capital component of stock of raw material.
Solution:
Estimated value of Stock of Raw Material
=Budgeted Units of Production x Cost per unit x Average holding
period in months or weeks or days/No. of months or weeks or day in a
year
=1,44,000x45x2/12
=₹ 10,80,000 (Answer)
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Estimating the Value of Current Assets (cont…)
(b) Stock of Work-in-Process:
In manufacturing/processing industries the production is carried on continuous
basis. At the end of the period, some work remains incomplete even though all
or some expenses have been incurred, this work is known as work-in-progress.
The work-in-process consists of direct material, direct labor and production
overheads locked up in these semi-finished goods.
The amount of funds estimated to be invested in work-in-process may be
computed as:
Estimated value of Stock of WIP=
Budgeted Units of Production x Cost per unit x Average holding period in
months or weeks or days/No. of months or weeks or day in a year
Note:
1. In the absence of information about stage of completion of WIP with regard
to material labor and overheads, 100% of material cost, and 50% of labor and
production overheads cost may be assumed as the estimated cost of work-in-
process.
2. In case cash cost approach’ is followed for estimation of working capital,
then depreciation should be excluded from production overheads while
calculating cost of work-in-process. However, under the total approach,
depreciation is also included.
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Question on estimating the value of Work-in-Progress
Question 2
You are given the following information regarding the work-in progress:
1. Proposed level of activity of production and sale is 1,44,000 units.
2. Cost per unit of:
a) raw material ₹45
b) direct labor 20
c) Overheads 40
Total cost 105
3. Materials are in process on an average of one month. The degree of
completion is 50% in respect of all elements of cost.
Required:
Estimate the working capital component of stock of raw material.
Solution:
Estimated value of Stock of Raw Material=
Budgeted Units of Production x Cost per unit x Average holding period in
months or weeks or days/No. of months or weeks or day in a year
=1,44,000x105x0.5x1/12
=₹6,30,000 (Answer)
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 Estimating the Value of Current Assets (cont…)
(c) Stock of Finished Goods:
The amount of funds to be invested in holding stock of finished
goods can be estimated on the basis of annual budgeted units of
production, estimated cost of production per unit and the average
holding period of finished goods stock by using the following
formula:
Estimated value of Stock of Finished Goods=
Budgeted Units of Production x Cost per unit x Average holding
period in months or weeks or days/No. of months or weeks or
day in a year
Note:
(i) Cost of production consist of 100% of material, labor and
production overheads costs.
(ii) Under the total cost approach, depreciation is included in the
cost of goods produced. However, depreciation is to be excluded
under the cash cost approach.
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 Question on estimating the value of Stock of Finished Goods
Question 3
You are given the following information regarding the stock of finished goods:
1. Proposed level of activity of production and sale is 1,44,000 units.
2. Cost per unit of:
– raw material ₹45
– direct labor 20
– Overheads 40
Total cost 105
3. Finished goods are in stock on an average of one month.
Required:
Estimate the working capital component of stock of finished goods.
Solution:
Estimated value of Stock of finished goods=
Budgeted Units of Production x Cost per unit x Average holding period in
months or weeks or days/No. of months or weeks or day in a year
=1,44,000x105x1/12
=₹12,60,000 (Answer)
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 Estimating the Value of Current Assets (cont…)
(d) Investment in Debtors/Receivables:
When the sales are made by a firm on cash basis, the amount is realized
immediately and no funds are blocked after sale period. However, in case of
credit sales, there is a time lag between sales and realization of cash. Thus,
funds are to be invested in receivables, i.e. debtors and bills receivables.
However, actual amount of funds locked up in receivables is only to the extent
of cost of sales and not the actual sales which include profit. The cost basis
estimation of debtors is more reasonable. But in case, total approach is
followed for estimation of working capital then receivables may be computed
on the basis of selling price.
Estimated value of Stock of Debtors/Receivables=
Budgeted Units of Production x Cost per unit x Average holding period in
months or weeks or days/No. of months or weeks or day in a year
Note:
Debtors/Receivables are to be estimated on cost basis rather than on price basis.
However, under total approach the debtors/receivables may be estimated on
sale price basis

10
Question on estimating the value of Debtors/Receivables
Question 4
You are given the following information regarding the stock of finished goods:
1. Proposed level of activity of production and sale is 1,44,000 units.
2. Cost per and selling price per unit of:
Raw material ₹45
Direct labor 20
Overheads 40
Total cost 105
Profit 15
Selling Price 120
3. 20% of sales are made in cash
4. Cash is recoverable from debtors on an average of two months after the credit sales.
Required:
Estimate the working capital component of stock of debtors.
Solution:
Estimated value of Debtors=
Budgeted Units of Production x Cost per unit x Average holding period in months or
weeks or days/No. of months or weeks or day in a year
=1,44,000x105x0.8x2/12
=₹20,16,000 (Answer)
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Estimating the Value of Current Assets (cont…)
(e) Cash and Bank Balance:
Cash is one of the current assets of a business. It is
needed at all times to keep the business going. A
business firm has always to keep a sufficient cash to
meet its obligations. Thus, a minimum desired cash
and bank balance to be maintained by a firm should
be considered as an important component of current
assets while estimating the working capital
requirements.
For example, A cash balance of ₹1,00,000 or
₹2,00,000 can be decided to maintain depending the
prevailing business situation.
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Estimating the Value of Current Liabilities
(a) Trade Creditors:
trade creditors refer to the creditors for purchase of
raw material, consumables, stores etc. The suppliers
of goods, generally, extend some period of credit in
the normal course of business. The trade credit
arrangement of a firm with its suppliers is an
important source of short-term finance. It reduces the
amount of net working capital required by a firm. The
amount of funds to be provided by creditors can be
estimated as follows:
Estimated Value of Creditors = Budgeted Units of
Production x Cost per unit x Average payment period
of creditors in months or weeks or days/No. of months
or weeks or days in a year
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Question on estimating the value of Trade Creditors
Question 1
On the basis of the following information provided to you,
compute the value of trade creditors:
1. Proposed level of activity of production and sale is
1,44,000 units.
2. Cost per unit of raw material ₹45
3. Credit allowed by suppliers is one month.
Solution:
Estimated value of Trade Creditors=
Budgeted Units of Production x Cost per unit x Average
payment period for creditors in months or weeks or
days/No. of months or weeks or day in a year
=1,44,000x45x1/12
= ₹ 5,40,000 (Answer)
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Estimating the Value of Current Liabilities (Cont…)
(b) Creditors for Wages and Other Expenses:
Wages and salaries are usually paid on monthly, fortnightly or weekly
basis for the services already rendered by employees. The longer the
payment period, the greater is the amount of current liability towards
employees or the funds provided by them. In the same manner, other
expenses may also have to be paid after the lag of a certain period. The
amount of such outstanding expenses reduces the level of net working
capital requirements of a firm.
The creditors for wages and other overheads may be computed as
follows:
Estimated value of Creditors and Other Expenses=
Budgeted Units of Production x Cost per unit x Average payment
period for creditors in months or weeks or days/No. of months or
weeks or day in a year
Note:
(i) The creditors for wages and each of the overheads may be calculated
separately.
(ii) In case of selling overheads, budgeted annual sales in units should
be considered in place of budgeted production units,
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Question on estimating the value of Creditors for Expenses
Question 2
On the basis of the following information provided to you,
compute the value of trade creditors:
1. Proposed level of activity of production and sale is 1,44,000
units.
2. Cost per unit of direct labor is ₹20 and cost per unit of
overheads is ₹40
3. Time lag in payment of wages and overhead is 1½ weeks.
Solution:
Estimated value of Creditors for wages and overheads=
Budgeted Units of Production x Cost per unit x Average payment
period for creditors in months or weeks or days/No. of months or
weeks or day in a year
=1,44,000x60x1.5/48
=₹ 2,70,000 (Answer)

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Question on working capital estimation
The following information is available from the records of Company X Ltd:
Product Cost Sheet per unit (₹):
Raw material 45
Direct labor 20
Overheads 40
Total 105
Add Profit 15
Selling price 120

Additional information:
1. Raw materials are in stock on an average for two months.
2. Materials are in process on an average of one month. The degree of completion is 50% in respect of all
elements of cost.
3. Finished goods are in stock for an average of one month.
4. Time lag in payment of wages and overheads is 1½ weeks.
5. Time lag in receipt of proceed from debtors is 2 months.
6. Credit allowed by suppliers is one month.
7. 20% of output is sold against cash.
8. The company expects to keep a cash balance of ₹ 1,00,000 .
9. The firm expects to manufacture 1,44,000 units in next year.
10. 10% provision of working capital for contingency is to be created.
You are required to prepare a statement of working capital requirement of the company for next year.
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Statement of Working Capital Requirement
Current Assets Amount(₹ ) Amount(₹)
Stock of Raw Material = 1,44,000x45x2/12 10,80,000
Work in progress =1,44,000x105x1/12x1/2 6,30,000
Finished goods=1,44,000x105x1/12 12,60,000
Debtors =144,000x105x0.8x2/12 20,16,000
Cash Balance 1,00,000 50,86,000
Current Liabilities
Creditors for raw materials=1,44,000x45x1/12 5,40,000
Creditors for wages & overheads
=1,44,000x 60x1.5/48 2,70,000 8,10,000
Working Capital (CA-CL) 42,76,000
Add: 10% Margin of WC for Contingency 4,27,600
Net Working Capital 47,03,600
Working Notes:
1. Debtors have been estimated at cost.
2. One month has been taken to contain 4 weeks

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