Working Capital Management

Question No. 1
Following information is forecasted by the CS Limited for the year ending 31st March,
2011 :
PARTICULARS Balance as at 1st Balance as at 31st
April, 2012 ₹ March, 2013 ₹
Raw material 45,000 65,356
Work in progress 35,000 51,300
Finished goods 60,181 70,175
Debtors 1,12,123 1,35,000
Creditors 50,079 70,469
Annual purchase of material 4,00,000
Annual cost of production 7,50,000
Annual cost of goods sold 9,15,000
Annual operating cost 9,50,000
Annual sales 11,00,000
You may take one year as equal to 365 days.
You are required to calculate
(i) Net operating cycle period
(ii) Number of operating cycles in a year
(iii) Amount of working capital requirement.
Answer
Avg Raw material = ₹55,178;
Avg WIP = ₹ 43,150;
Avg FG = ₹ 65,178;
Avg Debtors = ₹ 1,23,562;
Avg Creditors = ₹60,274;
Material consumption = op RM + purchases – Closing RM = 45,000+4,00,000-65,356
= 379,644;
Calculation of operating cycle
Calculation Days
R = Avg RM / Mat consumption * 365 (55,178 /379644 * 365) 53
W = Avg WIP / COP * 365 (43,150 / 7,50,000* 365) 21
F = Avg FG / COGS * 365 (65,178 / 9,15,000 * 365) 26
D= Avg Drs / Cr Sales * 365 (1,23,562 / 11,00,000 * 365) 41
-C = Avg Crs / Cr purchases * 365 (60,274 /4,00,000 * 365) -55
Operating cycle 86

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Cash turnover = 365 / 86 = 4.2 times

Amount of working capital requirement =Total cost / 365 * cycle = 9,50,000 / 365 *
86 = ₹ 2,23,836;

Question No. 2
A proforma cost sheet of a company provides the following particulars
Particulars Amount per unit ₹
Raw material cost 100.00
Direct Labour cost 37.50
Overheads cost 75.00
Total cost 212.50
Profit 37.50
Selling price 250.00

The company keeps raw material in stock on an average for one month; Work in
progress on an average for one week; and finished goods in stock on an average for
two weeks. The credit allowed by supplier is three weeks and company allow four
weeks credits to its debtors. The lag in payment of wages is one week and lag in
payment of overhead is two weeks
The company sells one fifth of the output against cash and maintains cash in hand and
bank put together at ₹ 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. Assume four week equal to one month.
Answer
WN – 1:
Units p.a. – 1,30,000
Units p.m. – 2,500 * 4 = 10,000
Units p.w. = 1,30,000/52 = 2,500
WN – 2:
WIP cost per unit:
TCB CCB
RM (80%) 80 80
Direct
labour 30 30
Over heads 60 60

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170 170
WN – 3:
FG cost p.u. TCB CCB
RM 100 100
Direct
labour 37.5 37.5
Over heads 75 75
212.5 212.5
WN – 4:
Debtors p.u. TCB CCB
Sales 250 250
- Profit - 37.5
250 212.5
Statement showing W.C. requirement
Particulars Calculation TCB CCB
Current assets
Raw Material 10,000 * 1 * 100 10,00,000 10,00,000
WIP 2,500 * 1 * 170 4,25,000 4,25,000
FG 2,500 * 2 * 212.5 10,62,500 10,62,500
Debtors (80% credit) 2,500 * 4 * 212.5 * 4/5 20,00,000 17,00,000
Cash 37,500 37,500
Total C.A 45,25,000 42,25,000

Current Liability:
Creditors 2,500 * 3 * 100 7,50,000 7,50,000
O/S wages 2,500 * 1 * 37.5 93,750 93,750
O/S OH 2,500 * 2 * 75 3,75,000 3,75,000
12,18,750 12,18,750

33,06,250 30,06,250
Methods of lending – Tandon Committee suggestions
This concept is not given in ICAI material) Additionally provided to you. Read once –
only for understanding a new concept. Not necessary for exams.
Like many other activities of the banks, method and quantum of short-term finance
that can be granted to a corporate was mandated by the Reserve Bank of India till
1994. This control was exercised on the lines suggested by the recommendations of a
study group headed by Shri Prakash Tandon.
The study group headed by Shri Prakash Tandon, the then Chairman of Punjab National
Bank, was constituted by the RBI in July 1974 with eminent personalities drawn from
leading banks, financial institutions and a wide cross-section of the Industry with a
view to study the entire gamut of Bank's finance for working capital and suggest ways

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for optimum utilisation of Bank credit. This was the first elaborate attempt by the
central bank to organise the Bank credit. The report of this group is widely known as
Tandon Committee report. Most banks in India even today continue to look at the
needs of the corporate in the light of methodology recommended by the Group.
As per the recommendations of Tandon Committee, the corporates should be
discouraged from accumulating too much of stocks of current assets and should move
towards very lean inventories and receivable levels. The committee even suggested
the maximum levels of Raw Material, Stock-in-process and Finished Goods which a
corporate operating in an industry should be allowed to accumulate these levels were
termed as inventory and receivable norms. Depending on the size of credit required,
the funding of these current assets (working capital needs) of the corporate could be
met by one of the following methods:

First Method of Lending:

Banks can give maximum 75% working capital gap, i.e. total current assets less current
liabilities other than bank borrowings (called Maximum Permissible Bank Finance or
MPBF) and the balance should be financed by owned funds and other ways. This
approach was considered suitable only for very small borrowers i.e. where the
requirements of credit were less than ₹10 lacs.
Second Method of Lending:
This is applicable for the entities who requires more than ₹ 10 lakh.
Under this method, Maximum WC loan can be given = (75% Current assets) – Current
liabilities;
So, Total current liabilities inclusive of bank borrowings could not exceed 75% of
current assets.
Third Method of Lending:
Under this method,
Maximum WC loan can be given = 75% of (Current Assets – Core current assets) –
Current Liabilities
CORE CURRENT ASSETS are the minimum level of raw material, WIP & FG that the
company has to maintain at every point of time. (Generally, this is given in the
question)
(This method was not accepted for implementation and hence is of only academic
interest).

Question No. 3
The data of ABC Ltd is as under:
Production for the year 69,000 units

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Finished goods inventory 3 months

Raw materials inventory 2 months consumption
Production process 1 month
Credit allowed by Creditors 2 months
Credit given to debtors 3 months
Selling price per unit ₹ 50 each
Raw material 50% of selling price
Direct wages 10% of selling price
Overheads 20% of selling price
There is regular production and sales cycle, and wages and overheads occur evenly.
Wages are paid in the next month of accrual. Material is introduced in the beginning
of production cycle. Work-in-process involves use of full unit of raw materials in the
beginning of manufacturing process and other conversion costs equivalent to 50%.
You are required to find out:-
1. Its working capital requirement, and
2. its permissible bank borrowing as per 1st and 2nd method of lending under
the Tandon committee norms.
Answer
WN – 1:
Total units p.a. – 69,000
Units p.m. – 69,000 / 12 = 5,750
WN – 2:
WIP cost per unit:
TCB CCB
RM 25 25
Direct labour 2.5 2.5
Over heads 5 5
32.5 32.5
WN – 3:
FG cost p.u. TCB CCB
RM 25 25
Direct labour 5 5
Over heads 10 10
40 40
WN – 4:
Drs p.u. TCB CCB
Sales 50 50
- Profit - 10
50 40

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Statement showing W.C. requirement

Particulars Calculation TCB CCB
Current assets
Raw Material 5,750 * 25 * 2 2,87,500 2,87,500
WIP 5,750 * 1 * 32.5 1,86,875 1,86,875
FG 5,750 * 3 * 40 6,90,000 6,90,000
Debtors 5,750 * 3 * 50 8,62,500 6,90,000
5,750 * 3 * 40
Total C.A 20,26,875 18,54,375

Current Liability:
Creditors 5,750 * 2 * 25 2,87,500 2,87,500
O/S wages 5,750 * 1 * 5 28,750 28,750
Total C.L 3,16,250 3,16,250
W.C. Requirement 17,10,625 15,38,125

Methods of Bank as per TANDON COMMITTEE:

TCB CCB
Method 1:
75% (CA - CL) 17,10,625 * 75% 15,38,125 * 75%
= 12,82,969 = 11,53,594

Method 2:
75% of CA - CL 15,20,156 - 3,16,250 13,90,781.25 - 3,16,250
= 12,03,906.25 = 10,74,531.25

Method 3:
75% of (CA – It cannot be calculated as core current assets information is not
CCA) - CL given in the problem.

Question No. 4
XYZ Co. Ltd. is a pipe manufacturing company. Its production cycle indicate that
material are introduced in the beginning of the production cycle. Wages and overhead
accrue evenly throughout the period of the cycle. Wages aloe paid in the next month
following the month of accrual. Work in progress include full unit of raw materials used
in the beginning. of the production process and 50% of wages and overhead are
supposed to be conversion costs. Detail of production process and the components of
working capital are as follows:
Production of pipes 12,00,000 units
Duration of the production cycle One month

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Raw material inventory held One month

Finished goods inventory held for Two month
Credit allowed by creditors One month
Credit given to debtors Two month
Cost price of raw material ₹ 60 per unit
Direct wages ₹ 10 per unit
Overheads ₹ 20 Per unit
Selling price of finished goods ₹ 100 per unit

Required to calculate:
1. The amount of working capital required for the company
2. Its maximum permissible bank finance under all the three methods of
working capital of lending norms as suggested by the Tondon Committee
assuming the value of core current assets ₹ 1,00,00,000
Answer
WN – 1:
Total units p.a. – 12,00,000
Units p.m. – 12,00,000 /12 = 1,00,000
WN – 2:
WIP cost per unit:
TCB CCB
RM 60 60
Direct labour 5 5
Over heads 10 10
75 75
WN – 3:
FG cost p.u TCB CCB
RM 60 60
Direct labour 10 10
Over heads 20 20
90 90
WN – 4:
Drs p.u TCB CCB
Sales 100 100
- Profit - 10
100 90

Statement showing W.C. requirement

Particulars Calculation TCB CCB

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Current assets
Raw Material 1,00,000 * 60 * 1 60,00,000 60,00,000
WIP 1,00,000 * 1 * 75 75,00,000 75,00,000
FG 1,00,000 * 2 * 90 1,80,00,000 1,80,00,000
Debtors 1,00,000 * 2 * 100 2,00,00,000 1,80,00,000
1,00,000 * 2 * 90
Total C.A 5,15,00,000 4,95,00,000

Current Liability:
Creditors 1,00,000 * 1 * 60 60,00,000 60,00,000
O/S wages 1,00,000 * 1 * 10 10,00,000 10,00,000
Total C.L 70,00,000 70,00,000

W.C. Requirement 4,45,00,000 4,25,00,000

Methods of Bank as per TANDON COMMITTEE:

Particulars TCB CCB
Method 1:
75% (CA - CL) = 3,33,75,000 = 3,18,75,000

= (3,86,25,000 – = (3,71,25,000 –
Method 2: 70,00,000) 70,00,000)
75% of CA - CL = 3,16,25,000 = 3,01,25,000

Method 3:
75% of (CA – Core CA) –
CL = 75% (515 – 100) – 70 = 75% (495 – 100) – 70
= 311.25 – 70 = 296.25 – 70
= 2,41,25,000 = 2,26,25,000
Question No. 5
The following information has been extracted from the record of a Company
Product Cost sheet ₹ / Unit
Raw Material 45
Direct wages 20
Overheads 40
Total 105
Profit 15
Selling price 120
- Raw material are in stock on an average of two months
- The material are in process on an average for 4 weeks. The degree of
completion is 50% for each item.
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 Working Capital Management

- Finished goods stock on an average is for one month.

- Time lag in payment of wages and overhead is 1.5 weeks.
- Time lag in receipts of proceeds from debtors is 2 months.
- Credit allowed by supplier is one month.
- 20% of the output is sold against cash.
- The company expects to keep cash balance of ₹ 100000.
- 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.
Answer
WN – 1:
Total units p.a. – 1,44,000
Units p.m – 1,44,000/12 = 12,000
Units p.week. – 1,44,000/52 = 2,770
WN – 2:
WIP cost p.a. (50%)
TCB CCB
RM 22.5 22.5
Direct labour 10 10
Over heads 20 20
52.5 52.5
WN – 3:
FG cost p.u TCB CCB
RM 45 45
Direct labour 20 20
Over heads 40 40
105 105
WN – 4:
Drs p.u TCB CCB
Sales 120 120
- Profit - 15
120 105

Statement showing W.C. requirement

Particulars Calculation TCB CCB
Current assets
Raw Material 12,000 * 2 * 45 10,80,000 10,80,000
WIP 2,770 * 4 * 52.5 5,81,700 5,81,700

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FG 12,000 * 1 * 105 12,60,000 12,60,000

Debtors 12,000 * 2 * 120 * 80% 23,04,000 20,16,000
12,000 * 2 * 105 * 80%
Cash 1,00,000 1,00,000
Total C.A 53,25,700 50,37,700
Current Liability:
Creditors 12,000 * 1 * 45 5,40,000 5,40,000
O/S wages 2,770 * 1.5 * 20 83,100 83,100
O/S OHs 2,770 * 1.5 * 40 1,66,200 1,66,200
Total C.L 7,89,300 7,89,300

W.C. Requirement 45,36,400 42,48,400

Question No. 6
A proforma cost sheet of a Company provides the following data:
Particulars ₹
Raw materials per unit 117
Labour cost per unit 49
Factory overhead per unit (include ₹ 18 dep.) 98
Total cost per unit 264
Profit 36
Selling price per unit 300
Following additional information is available:
Average raw material in stock 4 weeks
Average work in progress in stock (% completion with 2 weeks
respect to material 80%, other 60%)
Finished goods in stock 3 weeks
Credit period allowed to debtors 6 weeks
Credit availed from suppliers 8 weeks
Time lag in payment of wages 1 week
Time lag in payment of overheads 2 weeks

The Company sells one fifth of the output against cash and maintains cash balance of
₹ 2,50,000.
Required:
Prepare a statement showing the estimate of working capital needed to finance a
budgeted activity level of 78,000 units of production. You may assume that
production is carried on evenly throughout the year and wages and overhead accrue
similarly.

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Answer
Estimation of Working Capital Needs:
I Investment in Inventory
i. Raw material Inventory = 78,000 * (4/52) * Rs.117 = Rs.7,02,000
ii. Work-in-Process Inventory
Material = 78,000 * (2/52) * 0.8 * 117 = Rs. 2,80,800
Labour and overhead cost (Other than depreciation) = 78,000 * (2/52) * 0.6 * 129 =
2,32,200
Total WIP value = Rs.5,13,000
iii. Finished Goods Inventory (cash cost)
= 78,000 * (3/52) * 246 = Rs.11,07,000
II Investment in Debtors (Cash Cost)
=78,000 * (6/52) * 0.8 * 246 = Rs.17,71,200
III Cash balance Rs. 2,50,000
Investment in Current assets Rs.43,43,200
Current liabilities and deferred payment Rs.
i. Creditors = 78,000 * (8/52) * 117 = 14,04,000
ii. Wages Outstanding = 78,000 * (1/52) * 49 = 73,500
iii.Overheads outstanding (cash cost) = 78,000 * (2/52) * 80 =
2,40,000
Total Deferred payments 17,17,500
Net Working capital (Current assets – Non-interest bearing liabilities)
43,43,200 – 17,17,500 = Rs.26,25,700.
Question No. 7
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:
Particulars ₹
Sales ( At 2 months credit) 24,00,000
Materials consumed ( Suppliers credit 2 months) 6,00,000
Wages paid ( Monthly at the beginning of the subsequent month) 4,80,000
Manufacturing expenses (cash expenses are paid - one month in 6,00,000
arrear)
Administration expenses (cash expenses are paid - one month in 1,50,000
arrear)
Sales promotion expenses ( paid quarterly in advance) 75,000

The Company keeps one month stock each of raw materials and finished goods. A
minimum cash Balance of ₹ 80,000 is always kept. The company wants to adopt a 10%
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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.
Answer
Statement showing W.C. requirement
Particulars Calculation CCB
Current assets
Raw Material 6,00,000 * 1/12 50,000
FG (24,00,000 – 4,80,000 – 2,40,000) 16,80,000 * 1/12 1,40,000
Debtors 19,05,000 * 2/12 3,17,500
Cash 80,000
Advance 75,000 * ¼ 18,750
Total C.A 6,06,250

Current Liability:
Creditors 6,00,000 * 2/12 1,00,000
O/S wages 4,80,000 * 1/12 40,000
O/S Manf exp 6,00,000 * 1/12 50,000
O/S Admin exp 1,50,000 * 1/12 12,500
Total C.L 2,02,500

W.C. Requirement 4,03,750

10% safety margin 40,375
4,44,125
WN 1:
Calculation of depreciation:
Sales 24,00,000
- Material (6,00,000)
- Wages (4,80,000)
- Manufacturing exp (6,00,000)
7,20,000
- G.P 20% (4,80,000)
Depreciation 2,40,000
WN 2:
COGS 19,20,000
+ Admin Exp 1,50,000
+ Selling and distribution 75,000
Total cost 21,45000
+ Profit (b/f) 2,55,000
Sales 24,00,000
Cash cost for debtors = Sales – Dep – profit = 24,00,000 – 2,40,000 – 2,55,000 = Rs.
19,05,000

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Question No. 8
ABC Co. wishes to arrange overdraft facilities with its Bankers during the period April
to June 2013, when it will be manufacturing mostly for stock. Prepare a Cash Budget
for the above period from the following data, indicating the extent of the bank facilities
the company will require at the end of each month:
A.
Month Sales (₹) Purchases (₹) Wages (₹)
February, 2013 1,80,000 1,24,800 12,000
March, 2013 1,92,000 1,44,000 14,000
April, 2013 1,08,000 2,43,000 11,000
May, 2013 1,74,000 2,46,000 10,000
June, 2013 1,26,000 2,68,000 15,000

B. 50 % of credit sales are realised in the month following the sales and the
remaining 50 % in the second month following. Creditors are paid in the
month following the month of purchase. Wages are paid in next month.
C. Cash at Bank on 1-4-2013 (estimated) ₹ 25,000.
Answer
Cash Budget
Particulars April May June
Opening cash balance 25,000 53,000 -51,000
Credit sales
(1,92,000 * (1,08,000 * (1,74,000 *
50% of last month 50%) 50%) 50%)
96,000 54,000 87,000
(1,80,000 * (1,92,000 * (1,08,000 *
50% of 2nd last month 50%) 50%) 50%)
90,000 96,000 54,000
Total A 2,11,000 2,03,000 90,000

Creditors 1,44,000 2,43,000 2,46,000

(Previous month purchases)
Wages of last month paid in this
month 14,000 11,000 10,000
Total B 1,58,000 2,54,000 2,56,000
Closing balance (A - B) 53,000 -51,000 -1,66,000

Question No. 9
On 30th September, 2013 the balance sheet of M Ltd., (retailer) was as under:

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PARTICULARS ₹ PARTICULARS ₹
Equity Shares of ( 10 each 20,000 Equipment (at 20,000
fully paid cost)
Reserves 10,000 Less: 5,000
Depreciation
Trade creditors 40,000 15,000
Proposed dividend 15,000 Stock 20,000
Trade debtors 15,000
Balance at bank 35,000
Total 85,000 Total 85,000
The company is developing a system of forward planning and on 1st, 2013 it supplies
the following information :-
PARTICULARS Sales Purchases
Credit ₹ Cash ₹ Credit ₹
September 2013 ( actual) 15,000 14,000 40,000
October 2013 ( budget) 18,000 5,000 23,000
November 2013 ( budget) 20,000 6,000 27,000
December 2013 (budget) 25,000 8,000 26,000
All trade debtors are allowed one month's credit and are expected to settle promptly.
All trade creditors are paid in the months following delivery.
On 1st October, 2013, all equipments were replaced at a cost of ₹ 30,000. ₹ 14,000
was allowed in exchange for the old equipment and a net payment of ₹ 16,000 was
made.
The proposed dividend will be paid in Dec., 2013.
The following expenses will be paid. Wages ₹ 3,000 per month. Administration ₹ 1,500
per month. Rent ₹ 3,600 for the year up to 30th Sept. 2014 (to be paid in Oct, 2013).
You are required to prepare a cash budget for the months of October, November, and
December, 2013.
Answer
Cash Budget
Particulars October November December
Opening cash balance 35,000 (9,100) (12,600)
Cash sales 5,000 6,000 8,000
Cr. Sales
Last month Cr. Sales 15,000 18,000 20,000
Total A 55,000 14,900 15,400

Creditors 40,000 23,000 27,000

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(Previous month purchases)

Equipment’s (net) 16,000 - -
Proposed Dividend - - 15,000
Wages 3,000 3,000 3,000
Admin exp 1,500 1,500 1,500
Rent 3,600 - -
Total B 64,100 27,500 46,500
Closing balance (A - B) (9,100) (12,600) (31,100)

Question No. 10
ABC Company Ltd. has given the following particulars. You are required to prepare a
cash budget for the three months ending 31st December, 2013 :
(a)
Months Sales ₹ Materials ₹ Wages ₹ Overheads ₹
August 20,000 10,200 3,800 1,900
September 21,000 10,000 3,800 2,100
October 23,000 9,800 4,000 2,300
November 25,000 10,000 4,200 2,400
December 30,000 10,800 4,500 2,500
(b) Credit terms are:
(i) Sales / Debtors - 10% sales are on cash basis. 50% of the credit sales are
collected next month and the balance in the following month:
(ii) Creditors - Material 2 months
- wages 1 / 5 months
- overheads 1 / 2 months
(c) Cash balance on 1st October, 2013 is expected to be ₹ 8,000.
(d) A machinery will be installed in August, 2013 at a cost of ₹ 1,00,000. The
monthly installment of ₹ 5,000 is payable from October onwards.
(e) Dividend at 10% on preference share capital of ₹ 3,00,000 will be paid on
1st December, 2013.
(f) Advance to be received for sale of vehicle ₹ 20,000 in December.
(g) Income-tax (advance) to be paid in December ₹ 5,000.
Answer
Cash Budget
Particulars October November December
Opening cash balance 8,000 7,390 8,180
Cash sales (10%) 2,300 2,500 3,000
Cr. Sales
50% of Pr. Month 9,450 10,350 11,250

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Balance 2nd last month sales 9,000 9,450 10,350

Advance Received - - 20,000
Total A 28,750 29,690 52,780

Creditors
Material II nd last month 10,200 10,000 9,800
Wages: 1/5 of last month 760 800 840
4/5 of current mth 3,200 3,360 3,600
Overhead:
½ of last mth 1,050 1,150 1,200
½ of current mth 1,150 1,200 1,250
Machine instalment 5,000 5,000 5,000
Dividend (3,00,000 * 10%) - - 30,000
Advance tax - - 5,000
Total B 21,360 21,510 56,690
Closing bal (A - B) 7,390 8,180 (3,910)
WN 1:
Month Cash sales (10% of sales) Credit sales (90% of sales)
Aug 2,000 18,000
Sept 2,100 18,900
Oct 2,300 20,700
Nov 2,500 22,500
Dec 3,000 27,000

Question No. 11
ABC & Company is making sales of ₹ 16,00,000 and it extents a credit of 90 days to its
customers. 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
here under
Policy Terms Sales ₹
I 75 days 15,00,000
II 60 days 14,50,000
III 45 days 14,25,000
IV 30 days 13,50,000
V 15 days 13,00,000
The firm has a variable cost of 80% and a fixed cost of ₹ 1,00,000. The cost of capital is
15%. Evaluate different proposed policies and which policy should be adopted? (Year
may be taken as 360 days)
Answer
Profitability Statement of credit policy

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Particulars Present I II III IV V

Credit period in
days 90 75 60 45 30 15

16,00,00 15,00,00 14,50,00 14,25,00 13,50,00 13,00,00

Sales 0 0 0 0 0 0

- Variable cost 12,80,00 12,00,00 11,60,00 11,40,00 10,80,00 10,40,00

(80%) 0 0 0 0 0 0

Contribution 3,20,000 3,00,000 2,90,000 2,85,000 2,70,000 2,60,000

- Fixed cost 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000 1,00,000

2,20,000 2,00,000 1,90,000 1,85,000 1,70,000 1,60,000

Opp cost:
T.C * 15% * days
/360 51,750 40,625 31,500 23,250 14,750 7,125

1,68,250 1,59,375 1,58,500 1,61,750 1,55,250 1,52,875

Question No. 12
Star Limited, manufacturers of Color TV sets, are considering the liberalization of
existing credit terms to three large customers A, B and C. The credit and likely quantity
of TV sets that will be lifted by the customers are as follows:
Credit Period (Quantity Lifted of TV sets)
(Days)
A B C
0 1,000 1,000 --
30 1,000 1,500 --
60 1,000 2,000 1,000
90 1,000 2,500 1,500
The selling price per TV set is ₹ 9,000. The expected contribution is 20% of SP.
The cost of carrying debtors averages 20% per annum.
You are required to determine the credit period to the allowed to each customer.
(Assume 360 days in a year for calculation purposes)
Answer
Profitability Statement of credit policy
Particulars A B
Credit period in days 0 0
Sales 90,00,000 90,00,000

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- Variable cost (80%) 72,00,000 72,00,000

Contribution 18,00,000 18,00,000
WC 0 days hence 0 - -
Profit 18,00,000 18,00,000
Particulars A B
Credit period in days 30 30
Sales 90,00,000 1,35,00,000
- Variable cost (80%) 72,00,000 1,08,00,000
Contribution 18,00,000 27,00,000
WC = VC * 20% * days/360 1,20,000 1,80,000
Profit 16,80,000 25,20,000

Particulars A B C
Credit period in days 60 60 60
Sales 90,00,000 1,80,00,000 90,00,000
- Variable cost (80%) 72,00,000 1,44,00,000 72,00,000
Contribution 18,00,000 36,00,000 18,00,000
WC = VC * 20% * days/360 2,40,000 4,80,000 2,40,000
Profit 15,60,000 31,20,000 15,60,000
Particulars A B C
Credit period in days 90 90 90
Sales 90,00,000 2,25,00,000 1,35,00,000
- Variable cost (80%) 72,00,000 1,80,00,000 1,08,00,000
Contribution 18,00,000 45,00,000 27,00,000
WC = VC * 20% * days/360 3,60,000 9,00,000 5,40,000
Profit 14,40,000 36,00,000 21,60,000
Credit period to 3 customers
A = 0 days
B = 90 days
C = 90 days

Question No. 13
A company has prepared the following projections for a year:
Sales 21,000 units
Selling price per unit ₹ 40
Variable cost per unit ₹ 25
Total cost per unit ₹ 35
Credit period allowed One Month
The company propose to increase the credit period allowed to its customer from one
month to two months. It is envisaged that the change in the policy as above will
increase the sales by 8%.
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The company desires a return of 25% on its investment.

You are required to examine and advise whether the proposed credit policy should be
implemented or not.
Answer
We can solve this question in two ways
Total cost = 35
Variable cost = 25
So remaining is fixed cost = ₹10
Particulars Existing policy Proposed policy
Sales 8,40,000 9,07,200
- Variable cost 5,25,000 5,67,000
contribution 3,15,000 3,40,200
Fixed cost 2,10,000 2,10,000
1,05,000 1,30,200
Less Opportunity cost 15,313 32,375
Profit after COC 89,688 97,825
Proposed policy should be accepted as the profit after cost of capital is
greater.

Alternatively

Present units 21,000

Increase in sales 21,000 * 8% = 1,680
Contribution on increased sales 25,200
(40 – 25) = 15 = 1,680 * 15

Total cost of present production 7,35,000

21,000 * 35
Additional variable cost 42,000
1,680 * 25

Total cost (7,35,000 + 42,000) 7,77,000

Funds blocked for 2 months 1,29,500

7,77,000 * 2/12

Present funds blocked for 1 month 61,250

7,35,000 * 1/12

Extra block of funds 1,29,500 – 61,250 = 68,250

Due to change in the credit policy

% of return contribution increased sales
= Extra funds employed
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25,200
*100 = 36.92%
68,250
Note: The return due to change in credit policy comes to 36.92% which is more than
desired return of 25%. Hence the proposal of increasing the credit period from one
month to 2 months should be accepted.

Question No. 14
A firm has a current sales of ₹ 2,56,48,750. The firm has an utilized capacity. In order
to boosts its sales, It is considering the relaxation in its credit policy. The proposed
terms of the credit will be 60 days credit against the present policy of 45 days. As a
result, the bad debts increase from 1.5% to 2% of sales. The firm sales are expected to
increase by 10%. The variable operating costs are 72% of the sales. The firm corporate
tax rate is 35%, and it requires an after tax return of 15% on its investment. Should the
firm change its credit period?
Answer
Profitability Statement of credit policy
Particulars Present Increase @ 10%
Credit period 45 60
Sales 2,56,48,750 2,82,13,625
- Variable cost (72%) 1,84,67,100 2,03,13,810
Contribution 71,81,650 78,99,815
- Bad debts (1.5% or 2%) 3,84,731 5,64,273
PBT 67,96,919 73,35,542
Tax @ 35% 23,78,922 - 25,67,440
PAT 44,17,997 47,68,102
Increase in profit = 44,17,997 - 44,17,997
= 3,50,105
Receivable Investment Present 10 % increase
2,56,48,750 * 45/360 32,06,094 47,02,271
2,82,13,625 * 60/360

Therefore, increase in receivable investment = 47,02,271 – 32,06,094 = 14,96,177

Therefore, expected Rate % = Operating profit after tax = 3,50,105 * 100
= Increase in receivable investment
14,96,177
= 23.40%
The expected rate of return is 23.40% and it can be compared with required rate of
return of 15%, since the expected rate of return is more than required rate of return
hence it is beneficial (23.40% - 15%) = 8.4% extra return. Hence accept the project.
Question No. 15

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The sales manager of AB Ltd. suggests that if credit period is given for 1.5 month then
sales may likely to increase by ₹ 1,20,000 per annum. Cost of sales amounted to 90%
of sales. The risk of non-payment is 5%. Income tax rate is 30%. The expected return
on investment is ₹ 3,375 (after tax). Should the company accept the suggestion of Sales
manager?
Answer
Credit period 1.5 months
Rs.
Increase in Sales 1,20,000
- Cost of sales 90% 1,08,000
12,000
- Bad debts 5% 6,000
PBT 6,000
Tax @ 30% 1,800
4,200
The company shall accept the project as the return after tax is more than the
expected return of Rs. 3,375.

Question No. 16
An engineering company is considering its working capital investment for the year
2012-13. The estimated fixed assets and current liabilities for the next year are ₹ 6.63
crore and 5.967 crore respectively. The sales and EBIT depend on investment in its
current assets - particularly inventory and receivables. The company is examining the
following alternatives working capital policies:
Working Capital Investment In Estimated Sales EBIT (₹ I Crore)
Policy current (₹ In crore) (₹ In crore)
Conservative 11.475 31.365 3.1365
Moderate 9.945 29.325 2.9325
Aggressive 6.630 25.500 2.5500
You 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
Answer
(₹ in Crores)

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Conservati Modera Aggressi

1. Current assets 11.475 9.94 6.63
2. Fixed assets 6.630 6.63 6.63
3. Total assets 18.105 16.57 13.2
4. Current liabilities 5.967 5.96 5.96
5. Estimated sales 31.365 29.32 25.5
6. Estimated EBIT 3.1365 2.932 2.5
7. Current ratio {(1) / (4)} 1.92 1.6 1.1
Computation of following for each policy:

(i) Rate of return on total assets 17.32 17.69 19.23

(in percentages):
[(6)/(3)] × 100
(ii) Net working capital 5.508 3.978 0.663
position : (in crores)
[(1)−(4)]
(iii Current assets to fixed 1.73 1.50 1.00
assets ratio: [(1) / (2)]
(iv) Risk-return trade off:
The net working capital or current ratio is a measure of risk. Rate of return on total
assets is a measure of return. The expected risk and return are minimum in the case
of conservative investment policy and maximum in the case of aggressive investment
policy. The firm can improve profitability by reducing investment in working capital.
Question No. 17
You are given below the Profit & Loss Accounts for two years for a company:
Profit and Loss Account
Year 1 Year 2 Year 1 Year 2
₹ ₹ ₹ ₹
To Opening stock 80,00,000 1,00,00,000 By Sales 8,00,00,000 10,00,00,000
To Raw materials 3,00,00,000 4,00,00,000 By Closing 1,00,00,000 1,50,00,000
stock
To Stores 1,00,00,000 1,20,00,000 By Misc. 10,00,000 10,00,000
Income
To 1,00,00,000 1,60,00,000
Manufacturing
Expenses
To Other 1,00,00,000 1,00,00,000
Expenses
To Depreciation 1,00,00,000 1,00,00,000
To Net Profit 1,30,00,000 1,80,00,000 - -

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9,10,00,000 11,60,00,000 9,10,00,000 11,60,00,000

Sales are expected to be ₹ 12,00,00,000 in year 3.
As a result, other expenses will increase by ₹ 50,00,000 besides other charges. Only
raw materials are in stock. Assume sales and purchases are in cash terms and the
closing stock is expected to go up by the same amount as between year 1 and 2. You
may assume that no dividend is being paid. The Company can use 75% of the cash
generated to service a loan. COMPUTE how much cash from operations will be
available in year 3 for the purpose? Ignore income tax.
Answer
Projected Profit and Loss Account for the year 3
Year 2 Year 3 Year 2 Year 3
Actual Projected Actual Projected
(₹ in (₹ in (₹ in (₹ in
lakhs) lakhs) lakhs) lakhs)
To Materials 350 420 By Sales 1,000 1,200
consumed
To Stores 120 144 By Misc. 10 10
Income
To Mfg. Expenses 160 192
To Other expenses 100 150
To Depreciation 100 100
To Net profit 180 204
1,010 1,210 1,010 1,210
Cash Flow:
(₹ in lakhs)
Profit 204
Add: Depreciation 100
304
Less: Cash required for increase in stock 50
Net cash inflow 254
Available for servicing the loan: 75% of ₹ 2,54,00,000 or ₹ 1,90,50,000
Working Notes:
(i) Material consumed in year 2: 35% of sales.
Likely consumption in Year 3 = 1,200 * 35% = 420 lakh
(ii) Stores are 12% of sales, as in year 2.
(iii) Manufacturing expenses are 16% of sales.
Note: The above also shows how a projected profit and loss account is prepared.

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Question No. 18
Mosaic Limited has current sales of ₹ 15 lakhs per year. Cost of sales is 75 per cent of
sales and bad debts are one per cent of sales. Cost of sales comprises 80 per cent
variable costs and 20 per cent fixed costs, while the company’s required rate of return
is 12 per cent. Mosaic Limited currently allows customers 30 days’ credit, but is
considering increasing this to 60 days’ credit in order to increase sales.
It has been estimated that this change in policy will increase sales by 15 per cent, while
bad debts will increase from one per cent to four per cent. It is not expected that the
policy change will result in an increase in fixed costs and creditors and stock will be
unchanged.
Should Mosaic Limited introduce the proposed policy? ANALYSE (360 days = year)
Answer
New level of sales will be 15,00,000 * 1.15 = ₹ 17,25,000
Variable costs are 80% * 75% = 60% of sales Contribution from sales is therefore
40% of sales; Fixed Cost are 20% × 75% = 15% of sales
Particulars ₹ ₹
Proposed investment in debtors = Variable Cost +
Fixed Cost* = (17,25,000 × 60%) + (15,00,000 ×
15%) 2,10,000
60
= (10,35,000 + 2,25,000) ×
360
Current investment in debtors = [(15,00,000 *
30
60%) + (15,00,000 × 15%)] ×
360 93,750
Increase in investment in debtors 1,16,250
Increase in contribution = 15% * 15,00,000 * 90,000
40%
New level of bad debts = (17,25,000 * 4% ) 69,000
Current level of bad debts (15,00,000 × 1%) 15,000
Increase in bad debts (54,000)
Additional financing costs = 1,16,250 * 12% = (13,950)
Savings by introducing change in policy 22,050
Fixed Cost is taken at existing level in case of proposed investment as well
Advise: Mosaic Limited should introduce the proposed policy.
1. The Dolce Company purchases raw materials on terms of 2/10, net 30. A review
of the company’s records by the owner, Mr. Gautam, revealed that payments are
usually made 15 days after purchases are made. When asked why the firm did not
take advantage of its discounts, the accountant, Mr. Rohit, replied that it cost

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only 2 per cent for these funds, whereas a bank loan would cost the company 12
per cent.
(a) ANALYSE what mistake is Rohit making?
(b) If the firm could not borrow from the bank and was forced to resort to the
use of trade credit funds, what suggestion might be made to Rohit that
would reduce the annual interest cost? IDENTIFY.
Answer
(a) Rohit’s argument of comparing 2% discount with 12% bank loan rate is not
rational as 2% discount can be earned by making payment 5 days in advance
i.e. within 10 days rather 15 days as payments are made presently. Whereas
12% bank loan rate is for a year.
Assume that the purchase value is ₹100, the discount can be earned by
making payment within 10 days is ₹2. The interest cost on bank loan for 10
days would be ₹0.33 (100 × 12% × 10/365 days). The net benefit of ₹1.67 (2 –
0.33).
(b) If the bank loan facility could not be available then in this case the company
should resort to utilise maximum credit period as possible.
The maximum possible repayment period would be lower of two:
(i) 30 days as allowed by supplier
(ii) (No. of days / 365) * 100 * 12 % = 1.67 OR no. of days = 51 days
Therefore, payment should be made in 30 days to reduce the interest cost.

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