# Estimating Working Capital Requirements

### Reviewed by Subject Matter Experts

Updated on April 04, 2023

## 1. Estimating Working Capital Requirement Using Operating Cycle Method

### Problem

X Ltd Co. wants to estimate its working capital using the operating cycle method when:

• Estimated sales 20,000 units @ \$5 P.U.
• Production and sales will remain similar throughout the year

Customers are given 60 days of credit and 50 of days credit from suppliers. The 40-day supply of raw materials and a 15-day supply of finished goods are kept in store.

The production cycle lasts 20 days. All materials are issued at the start of each production cycle. One-third of the average working capital is kept as a cash balance for contingencies.

### Solution

 Total Op. Exp. For the Year \$ R.M. 20,000 x 250 50,000 Labor 20,000 x 1 20,000 Overheads 17,500 87,500
 Period of Production cycle Days Material storage days (pds.) 40 Finished goods storage (pds.) 15 Production cycle storage (pds.) 20 Av. collection (pds.) 60 135 Less: average payment (crs.) 50 85

(c) No. of operating cycles in the year = 365 / 85 = 4.3

(d) Working capital = 87,500 / 4.3 = \$20,349

Add: Reserve for contingencies 1 / 3 = 6,789 / \$27,132

## 2. Using Working Capital Method

### Problem

 \$ Raw materials (needed) 10,000 Store value 16,000 Average credit givers: Local sales 2 weeks credit 1,56,000 Outside sales 6 weeks credit 6,24,000 Time lag payment: For purchase (4 weeks) 1,92,000 For wages (2 weeks) 5,20,000

Contingencies allowances = 15%

Required: Calculate the amount of working capital.

### Solution

Current Assets

 Inventories: R.M. \$10,000 Stock of Store \$16,000 \$26,000

Account Receivables (Drs)

Local sales = (1,56,000 x 2) / 52 = \$6,000

Outside sales = (6 x 6,24,000) / 52 = \$72,000

Less: Current Liabilities

Accounts Payables (Crs.) = (1,92,000 x 4) / 52 = \$14,770

O/S Wages = (5,20,000 x 2) / 52 = \$20,000

Add: 15% for contingencies = 10,385

Total working capital required = \$79,615

## 3. Using Cash Forecasting Method

### Problem

John Trading Co. has asked you to prepare a working capital forecast using the following information:

• Issued share capital: \$400,000
• 8% deb.: \$1,50,000
• Fixed assets are valued at \$300,000
• Production: 100,000 units.
• Expected ratios of cost to selling price are: R.M. 50%, Wages: 10%, Overheads: 25% = 85%

Raw materials remain in stores for 2 months, finished goods remain in stores for 4 months, the credit allowed by crs. is 3 months from the date of delivery of goods (Rm), and the credit given to Drs. is 3 months from the date of dispatch.

The production cycle is 2 months. Additionally, the sale price per unit is \$6, and production and sales are uniform throughout the year.

## 4. Using Projected Balance Sheet Method

### Problem

Libro Ltd. has \$350,000 share capital, \$70,000 G.R., \$300,000 fixed assets, \$30,000 stock, \$97,500 Drs., and \$15,000 Crs.

The company proposes increasing the business stock level by 50% at the end of the year. Credits are doubled and it is proposed that machinery worth \$15,000 should be purchased.

Estimated profit during the year is \$52,500 after changing \$30,000 depreciation and 50% of profit for taxation.

Advance income tax is estimated at \$45,000. Credits are likely to be doubled, 5% dividends will be paid, and 10% dividends are to be proposed for the next year.

Drs. are estimated to be outstanding for 3 months. The sales budget shows \$750,000 as sales for the year to make a working capital forecast by the projected balance sheet method.

### Solution

 (i) Sh. cap. Fixed assets 300,000 Cap. (Given) 350,000 350,000 M. proposed purchase 15,000 Res. and surplus 70,000 Less dep. 315,000 17,500 30,000 Less dividend 10% 52,500 285,000 52,500 C.A. + Profit after tax 105,000 70,000 Stock 30,000 + 50% add. drs. 15,000 45,000 Less proposed div. 10% 35,000 Adv. tax 45,000 187,500 Current liabilities 277,500 Crs. 15,000 + (k) 15,000 30,000 Tax provision 52,000 Proposed div. 35,000 O/D (balance figure) 25,000 170,500 562,500 562,000