Scribd
Upload
67 views

AFN0005

Working capital refers to the capital required for conducting day-to-day business operations, including current assets like inventory, cash, and accounts receivable. There are several techniques used to forecast working capital requirements, including the operating cycle method, forecasting current assets and liabilities, cash forecasting, percentage of sales method, and projected balance sheet method. The operating cycle method estimates working capital needs based on the time periods for raw material procurement, production, inventory storage, and accounts receivable collection. Other methods analyze historical ratios, forecast cash flows, or project future balance sheets. Accurately determining working capital needs is important for business planning and financial management.

Uploaded by

AiDLo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
67 views

AFN0005

Working capital refers to the capital required for conducting day-to-day business operations, including current assets like inventory, cash, and accounts receivable. There are several techniques used to forecast working capital requirements, including the operating cycle method, forecasting current assets and liabilities, cash forecasting, percentage of sales method, and projected balance sheet method. The operating cycle method estimates working capital needs based on the time periods for raw material procurement, production, inventory storage, and accounts receivable collection. Other methods analyze historical ratios, forecast cash flows, or project future balance sheets. Accurately determining working capital needs is important for business planning and financial management.

Uploaded by

AiDLo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

AFN0005: Define Working Capital.

Briefly explain the techniques used in making working


capital forecast or Estimating Working Capital Requirements

Ans. Meaning of Working Capital:- Working capital management is an important aspect of


financial management. In business, money is required for fixed assets and working capital. Fixed
assets include land and building, plant and machinery, furniture and fittings etc. Fixed assets are
acquired to be retained in the business for a long period and yield returns over the life of such
assets. The main objective of working capital management is to determine the optimum amount
of working capital required. Generally, management of working capital means management of
current assets.

WORKING CAPITAL FORECASTING TECHNIQUES OR COMPUTATION OF


WORKING CAPITAL:

A number of methods are used to determine working capital needs of a business. The important
among them are:

Operating Cycle Method:- Operating cycle is the time span the firm requires in the purchase of
raw materials, conversion of raw materials into work in progress and finished goods, conversion
of finished goods into sales and in collecting cash from debtors. Larger the time span of
operating cycle, larger the investment in current assets. Hence, time period of each stage of
operating cycle is estimated and then working capital needed in each stage is computed on the
basis of cost of each item. Following factors should be taken into consideration while forecasting
working capital requirement on the basis of operating cycle method:

Cost of raw materials, wages and overheads.


 Period during which raw material remains in store before it is issued for production
purpose.
 Period of Production cycle.
 Period during which finished goods is stored before sale.
 Period of credit allowed to debtors and period of credit allowed by suppliers.
 Time lag in payment of wages and overheads.
 Minimum cash balance required to be maintained.

A certain percentage for contingencies may also be added to the above estimates to determine the
working capital requirement.

On the basis of operating cycle, the working capital can be forecasted in the following way:

STATEMENT SHOWING WORKING CAPITAL REQUIREMENT

Current Assets:
 Stock of Raw Materials:

 Work In Progress

Note: While calculating work in process it will be assumed that full Unit of raw material is
required in the beginning of the process whereas wages and overhead expenses accrue evenly
throughout the production cycle. Hence, raw material cost is taken at 100% and wages and
overheads are taken at 50% on an average basis.

 Stock of Finished Goods:

Cost of goods produced (i.e., yearly cost of raw materials +Wages + manufacturing &
administrative overheads (excluding depreciation)
 Debtors

Working Capital tied up in debtors should be estimated on the basis of cost of sales
(excluding depreciation):

 Cash and Bank Balance:

(i.e., minimum cash balance required to be maintained = --------

Less: Current Liabilities

(the working capital are lower to the extent such requirements are met through current liabilities)

 Trade Creditors:

 Wages

Note: If wages are paid at the end of each month, the average time lag in the payment of wages
will approximate to half-a- month. This is so, Because 1st day's wages are paid on the 30th day
of the month, extending credit for 29 days, the 2nd days wages are, again, paid on the 30th,
extending credit for 28 days, and so on. Thus, average time lag will approximate to half a month.

 Overheads

Estimated Working Capital Requirement


(2) Forecasting of Current Assets and Current Liabilities Method:- According to this
method, an estimate is made of forthcoming period's current assets and current liabilities
on the basis of factors like past experience, credit policy, stock policy and payment policy
of the previous years. First of all, such estimate is made for each current asset on the
basis of each month and then monthly requirements are converted into yearly requirement
of current assets. The estimated amount of current liabilities is deducted from this amount
in order to estimate the requirement of working capital. A certain percentage for
contingencies may also be added to this amount.

(3) Cash Forecasting Method:- Under this method, an estimate is made of cash receipts and
payments for the next period. Estimated cash receipts are added to the amount of working
capital which exists at the beginning of the year and estimated cash payments are
deducted from this amount. The difference will be the amount of working capital.

(4) Percentage of Sales Method:- Under this method, certain key ratios based on past year's
information are established. These ratios can be ratio of sales to raw material stock, ratio
of sales to semi-finished goods stock, ratio of sales to finished goods stock, ratio of sales
to debtors, ratio of sales to cash balance etc. After this, sales for the next year will be
estimated and the requirement of working capital will be determined on the basis of these
ratios.

(5) Projected Balance Sheet Method:- Under this method, an estimate is made of assets and
liabilities for a future date and a projected balance sheet is prepared for that future date.
The difference in current assets and current liabilities shown in projected balance sheet
will be the amount of working capital.

You might also like