Meaning, Concept and Policies of Working Capital

1. A newly formed company has applied to the commercial bank for the first time for
financing its working capital requirements. The following information is available about
the projections for the current year:
Estimated level of activity: 1,04,000 completed units of production plus 4,000 units of
work-in-progress. Based on the above activity, estimated cost per unit is:
Raw material
Direct wages
Overhead (exclusive of depreciation)
Total cost
Selling price

Rs 80 per unit
Rs 30 per unit
Rs 60 per unit
Rs 170 per unit
Rs 200 per unit

Raw materials in stock: average 4 weeks consumption, work-in-progress (assume 50%

completion stage in respect of conversion cost) (materials issued at the start of the
processing).
Finished goods in stock
Credit allowed by suppliers
Credit allowed to debtors/receivables
Lag in payment of wages

8,000 units
Average 4 weeks
Average 8 weeks
Average 1 weeks

Cash at banks (for smooth operation) is expected to be Rs 25,000.

Assume that production is carried on evenly throughout the year (52 weeks) and wages
and overheads accrue similarly. All sales are on credit basis only.
Find out:
(i) the net working capital required;
(ii) the maximum permissible bank finance under first and second method of
Financing as per Tandon Committee Norms.
(IPCC, Nov 1998)

Ans: (i) Rs 46,95,990; (ii) Under first method Rs 35,21,993,

Under second method Rs 33,20,125.

2. Q Ltd sells goods at a uniform rate of gross profit of 20% on sales including
depreciation as part of cost of production. Its annual figures are as under:

Sales (At 2 months credit)

Materials consumed (Suppliers credit 2 months)
Wages paid (Monthly at the beginning of the subsequent month)
Manufacturing expenses (Cash expenses are paid one month in arrear)
Administration expenses (Cash expenses are paid one month in arrear)
Sales promotion expenses (Paid quarterly in advance)

Rs
24,00,000
6,00,000
4,80,000
6,00,000
1,50,000
75,000

The company keeps one month stock each of raw materials and finished goods. A
minimum cash balance of Rs 80,000 is always kept. The company wants to adopt a 10%
safety margin in the maintenance of working capital.
The company has no work in progress.
Find out the requirements of working capital of the company on cash cost basis.
(IPCC, May 1999)

Ans: Working capital required Rs 4,44,125.

 3. Pollock Co. Pvt. Ltd, which is operating for the last 5 years, has approached
Sudershan Industries for grant of credit limit on account of goods bought from the latter,
annexing Balance Sheet and Income Statement for the last 2 years as below:
Pollock Co. Pvt. Ltd Balance Sheet
(Rs 000)
Current
Last
Last
Year
Year
Year
Share Capital
Equity (Rs 10)
1,400
Share Premium
750
Retained Earnings
Total Equity
2,150
First Mortgage
300
Second Mortgage
200
Bonds
120
80
Long-term Liabilities
700
Account Payable
Notes Payable
Secured Liabilities
Total Current Liabilities
2,850

Current
Year

600

600

Plant & Equipment

(less Dep.)

400

400

Land

900
1,900

700
1,700

200

300

Inventories

580

200

Account Receivables

350

300

300

Marketable Securities

120

Cash

100

500

800

300
600
100
1,000
3,400

60
220
70
350
2,850

1,500
750

Total Fixed Assets

Total Current Assets

2,250

1,150

3,400

Pollock Co. Pvt. LtdIncome Statement (Rs 000)

Current Year
Last Year
Sales
Income from Investments
5,800
Opening Inventory
Total Mfg. Costs
Ending Inventory
3,300

5,980
20
300
4,200
(580)

6,000

5,780
20

3,920

400
3,200
(300)

2,080
General and Admin. Expenses
750
Operating Income
1,750
Interest Exp.
Earnings before Taxes
1,688
Income-tax
674

2,500
950
1,130
60
1,070
480

Net Income after Taxes

1,014
Dividend declared and paid
250

590

Sudershan Industries has established the following broad guidelines for granting credit
limits to its customers.
(i) Limit credit limit to 10% of net worth and 20% of the net working capital.
(ii) Not to give credit in excess of Rs 1,00,000 to any single customer.
You are required to detail the steps required for establishing credit limits to Pollock Co.
Pvt. Ltd. In this case, what you consider to be reasonable credit limit?
(IPCC, May 2000)

Ans: Rs 30,000.00.

4. Dyer Ltd manufactures a variety of products using a standardized process, which

take one month to complete. Each production batch is started at the beginning of a month
and is transferred to finished goods at the beginning of the next month. The cost structure,
based on current selling price is ;
(%)
(%)
Sales Price
Variable Costs
Raw Materials
Other Variable Costs
Total Variable Costused for
Stock Valuation
Contribution

100
30
40
70
30

Activity levels are constant throughout the year and annual sales, all of which are made
on
credit
are
Rs 24,00,000. Dyer is now planning to increase sales volume by 50% and unit sales price
by 10%; such expansion would not alter the fixed costs of Rs 50,000 per month, which
includes monthly depreciation of plant of Rs 10,000. Similarly raw material and other
variable costs per unit will not alter as a result of the price rise.
In order to facilitate the envisaged increases several changes would be required in the
log run. The relevant changes are:
(i) The average credit period allowed to customers will increase to 70 days;
(ii) Suppliers will continue to be paid on strictly monthly terms;
(iii) Raw material stocks held will continue to be sufficient for one months
production;
(iv) Stocks of finished goods held will increase to one months output;
(v) There will be no change in the production period and other variable costs will
continue to be paid for in the month of production;
(vi) The current end-of-month working capital position is:
(Rs 000)
Raw Material
WIP
Finished Goods
Debtors
Creditors
Net Working Capital Excluding Cash

60
140
70

270
200
470
60
410

Compliance with the long-term changes required by the expansion will be

spread over several months. The points concerning the transitional arrangements
are:
(i) The cash balance anticipated at the end of May is Rs 80,000.
(ii) Upto and including June all sales will be made on one months credit.
From July all sales will be on the transitional credit terms which will
mean :
60% of sales will take 2 months credit
40% of sales will take 3 months credit
(iii) Sales price increase will occur with effect from sales in the month of
August.
(iv) Production will increase by 50% with effect from the month of July.
Raw material purchases made in June will reflect this.
(v) Sales volume will increase by 50% from sales made in October.
Required:
(a)
Show the long-term increase in annual profit and long-term working capital
requirements as a result of the plans for expansion and a price increase.
(Costs of financing the extra working capital requirements may be ignored).
(b)
Produce a monthly cash forecast for the period from June to December, the
first seven months of the transitional period. Prepare also a working capital
position at the end of December.
(c)
Using your findings for (a) and (b) above, make brief comments to the
management of Dyer Ltd on the major factors concerning the financial
aspects of the expansion which should be brought to their attention.
Assume that there are 360 days in a year and each month contains 30 days.
(IPCC, Nov. 2000)

Ans: (a) Increase in Profit Rs 7,20,000. Net working capital requirement

Rs 12,12,000; (b) Shortage of cash in the month of December is Rs 3,62,000.

5. A company is considering its working capital investment and financial policies for
the next year. Estimated fixed assets and current liabilities for the next year are Rs 2.60
crores and Rs 2.34 crore respectively. Estimated Sales and EBIT depend on current assets
investment, particularly inventories and book-debts. The Financial Controller of the
company is examining the following alternative Working Capital Policies:
Working Capital
Policy
Conservative
Moderate
Aggressive

Investment in
Current Assets
4.50
3.90
2.60

Estimated
Sales
12.30
11.50
10.00

(Rs Crores)
EBIT
1.23
1.15
1.00

After evaluating the working capital policy, the Financial Controller has advised the
adoption of the moderate working capital policy. The company is now examining the use
of long-term and short-term borrowings for financings its assets. The company will use
Rs 2.50 crores of the equity funds. The corporate tax rate is 35%. The company is
considering the following debt alternatives:
(Rs crore)
Financing Policy
Debt
Conservative

Short-term Debt
0.54

Long-term
1.12

Moderate
Aggressive
Interest rate-Average

1.00
1.50
12%

0.66
0.16
16%

You are required to calculate the following:

(1)
Working Capital Investment for each Policy;
(a)
Net Working Capital position
(b)
Rate of Return
(c)
Current ratio.
(2)
Financing for each policy:
(a)
Net Working Capital position
(b)
Rate of Return on Shareholders equity
(c)
Current ratio.
(IPCC, Nov. 2001)

Ans:
Working Capital Policy
Aggressive
(1)
(a)
(b)
19.2%
(c)
(2)
(a)
(b)
24.4%
(c)

Conservative

Moderate

Rs in crores 2.16
17.3%

1.56
17.7%

1.92
Rs in crores 1.02
23.6%

1.67
0.56
24%

1.35

1.17

6. The following information has been extracted from the records of a Company:
Product cost sheet
Raw materials
Direct labour
Overheads
Total
Profit
Selling price

Rs/unit
45
20
40
105
15
120

Raw materials are in stock on an average of two months.

The materials are in process on an average for 4 weeks. The degree of

completion is 50%.

Finished goods stock on an average is for one month.

Time log in payment of wages and overheads is 1 weeks.

Time log in receipt of proceeds from debtors is 2 months.

Credit allowed by suppliers is one month.

20% of the output is sold against cash.

The company expects to keep a Cash balance of Rs 1,00,000.

Take 52 weeks per annum.

The Company is poised for a manufacture of 1,44,000 units in the year.
You are required to prepare a statement showing the Working Capital
requirements of the Company.
(IPCC, Nov. 2002)

Hint:

Rs
1,72,80,000
64,80,000
28,80,000
57,60,000

(a) Total Sales

(b) Annual Raw Materials Requirements
(c) Annual Direct Labour Cost
(d) Annual Overhead Costs

Ans: Net Working Capital: Rs 45,36,307.

7. An engineering company is considering its working capital investment for the year
2003-04. The estimated fixed assets and current liabilities for the next year are Rs 6.3
crores and Rs 5,967 crores respectively. The sales and earnings before interest and taxes
(EBIT) depend on investment in its current assets particularly inventory and receivables.
The company is examining the following alternative working capital policies:
Working Capital Policy
Conservative
Moderate
Aggressive

Investment in Current Assets

(Rs Crores)
11.475
9.945
6.63

Estimated Sales
EBIT
(Rs Crores) (Rs Crores)
31.365
3.1365
29.325
2.9325
25.50
2.55

Your are required to calculate the following for each policy :

(i) Rate of return on total assets.
(ii) Net working capital position.
(iii) Current assets to fixed assets ratio.
(iv) Discuss the risk-return trade-off of each working capital policy.
Ans:

(IPCC, May 2003)

Working Capital Investment Policy
(Rs in crores)
Conservative
Moderate
Aggressive
(i)
17.32
17.6919.23
(ii)
5.508
3.9780.663
(iii)
1.73
(iv)The firm can improve profitability by
reducing investment in working capital.

8. (a) The following annual figures relate to MNP Limited:

Sales (at three months credit)
Materials consumed (suppliers extend one and half months credit)
Wages paid (one month in arrear)
Manufacturing expenses outstanding at the end of the year
(cash expenses are paid one month in arrear)
Total Administrative expenses for the year
(cash expenses are paid one month in arrear)
Sales Promotion expenses for the year (paid quarterly in advance)

Rs
90,00,000
Rs
22,50,000
Rs
18,00,000
Rs
20,00,000
Rs
6,00,000
Rs
12,00,000

The company sells its products on gross-profit of 25% assuming depreciation as a

part of cost of production. It keeps two months stock of finished goods and one months
stock of raw materials as inventory. It keeps cash balance of Rs 2,50,000.
Assume a 5% safety margin, work out the working capital requirements of the company
on cash cost basis. Ignore work-in-progress.
(IPCC, May 2004)

Ans: Working Capital Requirement (on cash cost basis) is Rs 34,93,750.

9. XYZ Co. Ltd is a pipe manufacturing company. Its production cycle indicates that
materials, are introduced in the beginning of the production cycle; wage and overhead
accrue evenly thorugh out the period of the cycle. Wages are paid in the next month
following the month of accrual. Work-in-process includes full units of raw materials used
in the beginning of the production process and 50% of wages and overheads are supposed
to be conversion costs. Details of production process and the components of working
capital are as follows:
Production of pipes
Duration of the production cycle
Raw materials inventory held
Finished goods inventory held for
Credit allowed by creditors
Credit given to debtors
Cost price of raw materials
Direct wages
Overheads
Selling price of finished pipes

12,00,000 units
One month
One month consumption
Two months
One months
Two months
Rs 60 per unit
Rs 10 per unit
Rs 20 per unit
Rs 100 per unit

Required to calculate:
(i) The amount of working capital required for the company.
(ii) Its maximum permissible bank finance under all the three methods of lending
norms as suggested by the Tandon Committee, assuming the value of core
current assets: Rs 1,00,00,000.
(IPCC, May 2005)

Ans: (i) Net working capital Rs 4,25,00,000; (ii) Maximum possible

bank Finance as per Method I Rs 3,18,75,000, Method II Rs 3,01,25,000
and in Method III Rs 2,26,25.000

10. A pro forma cost sheet of a company provides the following particulars :
Raw materials cost
Direct labour cost
Overheads cost
Total cost
Profit
Selling Price

Amount per unit

100
37.50
75
212.50
37.50
2.50

The company keeps raw material in stock, on an average for one month; work-inprogress, on an average for one week; and finished goods in stock, on an average for two
weeks.
The Credit allowed by suppliers is three weeks and company allows four weeks credit
to its debtors. The lag in payment of wages is one week and lag in payment of overhead
expenses is two weeks.

The company sells one-fifth of the output against cash and maintains Cash-in-hand and
at bank put together at Rs 37,500.
Required:
Prepare a statement showing estimate of Working Capital needed to finance an activity
level of 1,30,000 units of production. Assume that production is carried on evenly
throughout the year, and wages and overheads accrue similarly work-in-progress stock is
80% complete in all respects.
(IPCC, Nov. 2006)

Hint: For Calculation puroses, 4 weeks has been considered as equivalent to a month.
Ans: Net working Capital needs Rs 30,06,250.

11. A newly formed company has applied to the Commercial Bank for the first time
for financing its working capital requirements. The following information is available
about the projections for the current year:
Elements of cost:
Raw material
Direct labour
Overhead
Total cost
Profit
Sales

Per unit Rs
40
15
30
85
15
100

Other information:
Raw material in stock: Average 4 weeks consumption, Work-in-progress
(completion
stage,
50 per cent), on an average half a month. Finished goods in stock: on an average,
one month.
Credit allowed by suppliers in one month.
Credit allowed to debtors is two month.
Average time lag in payment of wages is 1 weeks and 4 weeks in
overhead expenses.
Cash in hand and at bank is desired to be maintained at Rs 50,000.
All Sales are on credit basis only.
Required :
(i) Prepare statement showing estimate of working capital needed to
finance an activity level of 96,000 units of production. Assume that
production is carried on evenly throughout the year, and wages and
overhead accrue similarly. For the calculation purpose 4 weeks may be
taken as equivalent to a month and 52 weeks in a year.
(ii) From the above information calculate the maximum permissible bank
finance by all the three methods for working capital as per Tandon
Committee norms; assume the core current assets constitute 25% of the
current assets.
(IPCC, Nov. 2007)

Ans: (i)Net Working Capital = Rs 18,26.924

(ii) Maximum Permissible Bank Finance as per Tandon Committee :
Method I = Rs 13,70,193
Method II = Rs 12,30,578

Method III = Rs 7,83,318.

12. MN Ltd is commencing a new project for manufacture of electric toys. The
following cost information has been ascertained for annual production of 60,000 units at
full capacity:
Rs
Raw materials
20
Direct labour
15
Manufacturing overheads :
Variable
Fixed
25
Selling and Distribution overheads:
Variable
Fixed
4
Total cost
64
Profit
16
Selling price
80

Amount per unit (Rs)

15
10
3
1

In the first year of operations expected production and sales are 40,000 units and 35,000
units respectively. To assess the need of Working capital, the following additional
information is available:
(i)
Stock of Raw materials .. 3 months consumption.
(ii)
Credit allowable for debtors .. 1 months.
(iii)
Credit allowable by creditors .. 4 months.
(iv)
Lag in payment of wages .. 1 month.
(v)
Lag in payment of overheads .. month.
(vi)
Cash-in-hand and Bank is expected to Rs 60,000.
(vii) Provision for contingencies is required @ 10% of Working capital
requirement including that provision.
You are required to prepare a projected statement of Working capital
requirement for the first year of operations. Debtors are taken at cost.
(IPCC, May 2000)

Hint:
Purchase of Raw Material during the first year
Raw Material consumed during the year
Add : Closing Stock of Raw Material (3 months consumption)

Less : Opening Stock of Raw Material

Purchases during the year

Rs
8,00,000
2,00,000
10,00,000
Nil
10,00,000

Ans : Estimated working Capital Requirement: Rs 4,99,769.