Management of Working Capital By Heena Malhotra

Forecast/ Estimate of Working Capital Requirements O The following points highlight the top five methods for estimating working capital requirements, i.e o 1. Percentage of Sales Method o 2. Regression Analysis Method o 3. Cash Forecasting Method o 4. Operating Cycle Method o 5. Projected Balance Sheet Method By Heena Malhotra

1. Percentage of Sales Method: o If sales for the year 2017 amounted to Rs 30,00,000 and working capital required was Rs 6,00,000; the requirement of working capital for the year 2018 on an estimated sales of Rs 40,00,000 shall be Rs 8,00,000; i.e. 20% of Rs 40,00,000 By Heena Malhotra

1. Percentage of Sales Method: O This method of estimating working capital requirements is based on the assumption that the level of working capital for any firm is directly related to its sales value. o If past experience indicates a stable relationship between the amount of sales and working capital, then this basis may be used to determine the requirements of working capital for future period O The individual items of current assets and current liabilities can also be estimated on the basis of the past experience as a percentage of sales. O This method is simple to understand and easy to operate but it cannot be applied in all cases because the direct relationship between sales and working capital may not be established.

2. Regression Analysis Method (Average Relationship between Sales and Working Capital): O This method of forecasting working capital requirements is based upon the statistical technique of estimating or predicting the unknown value of a dependent variable from the known value of an independent variable. It is the measure of the average relationship between two or more variables, i.e.; sales and working capital, in terms of the original units of the data. O The relationships between sales and working capital are represented by the equation: Y-a+bx By Heena Malhotra

Where, y Working capital (dependent variable) a Intercept of the least square b Slope of the regression line x Sales (independent variable) For determining the values a, and b' two normal equations are used which can be solved simultaneously: yabE By Heena Malhotra

3. Cash Forecasting Method: O This method of estimating working capital requirements involves forecasting of cash receipts and disbursements during a future period of time. Cash forecast wil include all possible sources from which cash will be received and the channels in which payments are to be made so that a consolidated cash position is determined O This method is similar to the preparation of a cash budget. The excess of receipts over payments represents surplus of cash and the excess of payments over receipts causes deficit of cash or the amount of working capital required. By Heena Malhotra

4. Operating Cycle Method: O 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. o It involves purchase of raw materials and stores, its conversion into stock of finished goods through work-in-process with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables, realization of cash and this cycle continues again from cash to purchase of raw material and so on. The speed/time duration required to complete one cycle determines the requirement of working capital - longer the period of cycle, larger is the requirement of working capital and vice-versa By Heena Malhotra

Raw Material Recei vable WIP Sales FG By Heena Malhotra

The duration of working capital cycle may vary depending on the nature of the business. In the form of an equation, the operating cycle process can be expressed as follows: Operating Cycle R+ W F+D-C Where, R Raw material storage period W-Work-in-progress holding period FFinished goods storage period DReceivables (Debtors) collection period CCredit period allowed by suppliers (Creditors). By Heena Malhotra

The duration of working capital cycle may vary depending on the nature of the business. In the form of an equation, the operating cycle process can be expressed as follows: Operating Cycle R+ W F+D-C Where, R Raw material storage period W-Work-in-progress holding period FFinished goods storage period DReceivables (Debtors) collection period CCredit period allowed by suppliers (Creditors). By Heena Malhotra

4. Operating Cycle Method: O 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. O It involves purchase of raw materials and stores, its conversion into stock of finished goods through work-in-process with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables, realization of cash and this cycle continues again from cash to purchase of raw material and so on. The speed/time duration required to complete one cycle determines the requirement of working capital - longer the period of cycle, larger is the requirement of working capital and vice-versa By Heena Malhotra

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