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CA.CS.MBA.

Naveen, Rohatgi WORKING CAPITAL

TYBMS: FM

Meaning: Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the interrelationship that exists between them. The term current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash within one year. The major current assets are cash, marketable securities, accounts receivable and inventory. Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills payable, bank overdraft, and outstanding expenses. The goal of working capital management is to manage the firm's current assets and liabilities in such a way that a satisfactory level of working capital is maintained. This is so because if the firm cannot maintain a satisfactory level of working capital, it likely to become insolvent and may even be forced into bankruptcy. The current assets should be large enough to cover its current liabilities in order to ensure a reasonable margin of safety. Each of the current assets must be managed efficiently in order to maintain the liquidity of the firm while not keeping too high a level of any one of them. Each of the short-term sources of financing must be continuously managed to ensure that they are obtained and used in the best possible v The interaction between current assets and current liabilities is, therefore, the main theme of theory of working management. Determinants of Working Capital/ Factors affecting working capital (NOV 02, NOV 05, NOV 04,MAY 2005, MAY 2008) A firm should plan its operations in such a way that it should have neither too much nor too little working capital. The total working capital requirement is determined by a wide variety of factors. These factors, however, affect different enterprises differently. They also vary from time to time. In general, the following factors are involved in a proper assessment of the quantum of working capital required. General Nature of Business The working capital requirements of an enterprise are basically related to the conduct of business. For instance, public utilities .i.e railways and airlines have certain features two relevant features are: (i) the cash nature of business, that is cash sale, and (ii) sale of services rather than commodities. In view of these features they do not maintain big inventories and have, therefore, probably the least requirement of working capital. At the other extreme are trading concern (retail). The nature of their business, is such that they have to maintain a sufficient amount of inventories and book debts. They have necessarily to invest proportionately large 1 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

amounts in working capital. The manufacturing enterprises fall, in a sense, between these two extremes. Production Cycle Another factor which has a bearing on the quantum of working capital is the production cycle. The term production or manufacturing cycle refers to the time involve in the manufacture of goods. It covers the time-span between the procurement of raw materials and the completion of the manufacturing process leading to the production of finished goods. The longer the time-span (i.e the production cycle), the larger will be the tied-up funds and, therefore, the larger is the working capital needed and vice versa. Business Cycle The working capital requirements are also determined by the nature of the business cycle. Business fluctuations lead to cyclical and seasonal changes which, in -turn, cause a shift in the working capital position, particularly for temporary working capital requirements. The variations in business conditions may be in two directions: (i) upward phase when boom conditions prevail, and (ii) downswing phase when economic activity is marked by a decline. During the upswing of business activity, the need for working capital is likely to grow to cover the lag between increased sales and receipt of cash as well as to finance purchases of additional material to cater to the expansion of the level of activity. Additional funds may be required to invest in plant and machinery to meet the increased demand. The downswing phase of the business cycle has exactly an opposite effect on the level of working capital requirement. Credit Policy The credit policy relating to sales and purchases also affects the working capital. The credit policy influences the requirement of working capital in two ways: (i) through credit terms granted by the firm to its customers/buyers of goods; (ii) credit terms available to the firm from its creditors. The credit terms granted to customers - The credit sales result in higher book debts (receivables). Higher book debts mean more working capital. On the other hand, if liberal credit terms are available from the suppliers of goods (trade creditors), the need for working capital is less. Growth and Expansion As a company grows, it is logical to expect that a larger amount of working capital is required. The growth industries require more working capital than those that are static. The critical fact. however, is that the need for increased working capital funds does not follow the growth in business activities but precedes it. Advance planning of working capital is, therefore, a continuing necessity for growing concern or else the company may have substantial earnings but little cash. Non Availability of Raw Material The availability or otherwise of certain raw materials on a continuous basis without interruption would sometimes affect the requirement of capital. There may be some materials which cannot be procured easily either because of their sources are few or they are irregular. To sustain smooth production, therefore, the firm might be compelled to purchase and stock them far in excess of genuine production needs. This will result in an excessive inventory of such materials. 2 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Operating Efficiency: Efficiency in controlling operating cost and efficient utilization of current asset improves the profitability and operating working capital cycle thereby keeping the working capital investment at a lower level. Price level changes: Generally rising price level will require the firm to maintain higher amount of working capital. Same level of current assets will need increased investment when price increases. However the company which can immediately revise their product prices with rising price level will not face severe working capital. Seasonality of operations: Firms which have marked seasonality in their operations usually have high fluctuating working capital requirement. Example A firm manufacturing air conditioners. The sale of air conditioners reaches peak during summer season and drops sharply during winter . The working capital need of such a company is likely to increase during summer period and fall during winter season. Market conditions and Competition : The degree of competition prevailing in the market has an important bearing on working capital needs . When competition is large a huge amount of inventory is needed to promptly serve the customers which may not be inclined to wait because other manufacturers are ready to meet their needs . Further liberal credit terms may offered to attract customers in a highly competitive market. Thus the working capital needs tend to be high. Reverse is the situation in case of weak market Technological Changes Finally, technological changes can cause significant changes in the level of working capital. If a new process emerges as a result of technological developments, which shortens the operating cycle, it reduces the need for working capital and vice versa. Concepts and Definition of working capital MAY 2002. Gross working capital/ Current assets : Current assets are assets that are easily convertible into cash during operating cycle or within a period of one year. . They normally represents cash, bank, debtors, short term investments , sundry debtors, Bills receivables, inventories, prepaid expenses. Goss working capital is also referred as currents assets. MAY 2002 Net working capital: / Net current assets : It refers to the difference in between total current assets and current liabilities . Current liabilities are those liabilities which are payable within a period of one year or within operating cycle . They include sundry creditors, bills payable, bank overdraft, outstanding expenses, dividend payable. 3 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi TYPES OF WORKING CAPITAL

TYBMS: FM

NOV 2001 Permanent and Temporary Working Capital To carry on business, a certain minimum level of working capital is necessary on a continuous and uninterrupted basis. For all practical purposes, this requirement has to be met permanently as with other fixed assets. This requirement is referred to as permanent or fixed working capital. Any amount over and above the permanent level of working capital is temporary fluctuating or variable working capital. The position of the required working capital is needed to meet fluctuations in demand consequent upon changes in production and sales as a result of seasonal changes.

FIGURE 13.2 Permanent and Temporary Working Capital

FIGURE 13.3 Permanent and Temporary Working Capital Working capital cycle/ operating cycle/ cash back to cash: The continuing flow cash to suppliers, to inventory , to accounts receivable and back into cash is called operating cycle. . In other words the term cash cycle refers to the length of time necessary to complete the following cycle of events: 1. Conversion of cash into inventory; 2. Conversion of inventory into receivables; 3. Conversion of receivables into cash.

4 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

1Conversion of cash into inventory: Cash gets converted into inventory. This would include purchase of raw material , conversion of raw material into WIP and finished goods. In case of trading organization this stage would be shorter as there would bee no manufacturing activity and cash will be converted into inventory (finished goods) directly . This stage will be totally absent in case of service organization. 2. Conversion of inventory into receivables; In this stage of the cycle, the inventory is converted into receivables as credit sales are made to the customers 3 Conversion of receivables into cash. This represents the stage when receivables are collected . This stage completes the operating cycle. Working capital Financing Trade credit refers to the credit extended by the supplier of goods and services in the normal course of transaction/business/sale of the firm. According to trade practices, cash is not paid immediately for purchases but after an agreed period of time. Thus, deferral of payment (trade credit) represents a source of finance for credit purchases. BANK CREDIT Working capital finance is provided by banks in five ways: (i) cash credits/overdrafts, (ii) loans, (iii) purchase/discount bills, (iv) letter of credit and (v) working capital term loans Cash Credit/Overdrafts Under cash credit/overdraft form/arrangement of bank finance, the bank specifies a predetermined borrowing/credit limit. The borrower can draw/borrow up to the stipulated credit/overdraft limit. Within the specified limit, any number of drawals/drawings are possible to the extent of his requirements periodically. Similarly, repayments can be made whenever desired during the period. Loans Under ,this arrangement, the entire amount of borrowing is credited to the current account of the borrower or released, in cash. The borrower has to pay interest on the total amount. The loans are repayable on demand or in periodic installments. Bills Purchased/Discounted The amount made available under this arrangement is covered by the cash credit and overdraft limit. Before discounting the bill, the bank satisfies itself about the credit-worthiness of the drawer and the genuineness of the bill. To popularise the scheme, the discount rates are fixed at lower rates than those of cash credit, the difference being about 1-1.5 per cent. The discounting banker asks the 5 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

drawer of the bill (i.e. seller of goods) to have his bill accepted. by the drawee (buyers') bank before discounting it. Letter of Credit While the other forms of bank credit are direct forms of financing in which banks provide funds as well as bear risk, letter of credit is an indirect form of working capital financing and banks assume only the risk, the credit being provided by the supplier himself. The purchaser of goods on credit obtains a letter of credit from a bank. The bank undertakes the responsibility to make payment to the supplier in case the buyer fails to meet his obligations. Thus, the modus operandi of letter of credit is that the supplier sells goods on credit/extends credit (finance) to the purchaser, the bank gives a guarantee and bears risk only in case of default by the purchaser. Mode of Security Banks provide credit on the basis of the following modes of security: Hypothecation Under this mode of security, the banks provide credit to borrowers against the security of movable property, usually inventory of goods. The goods hypothecated, however, continue to be in the possession of the owner of these goods (i.e., the borrower). The rights of the lending bank (hypothecatee) depend upon the terms of the contract between the borrower and the lender. Although the bank does not have physical possession of the goods, it has the legal right to sell the goods to realise the outstanding loan. Hypothecation facility is normally not available to new borrowers. Pledge: Pledge, as a mode of security, is different from hypothecation in that in the Pledge former, unlike in the latter, the goods which are offered as security are transferred to the physical possession of the lender. An essential prerequisite of pledge, therefore, goods as security/ is that the goods are in the custody of the bank. The borrower who offers the collateral to security is, called a 'pawnor' (pledgor), while the bank is called the 'pawnee' obtain a short-(pledgee). The lodging of the goods by the pledgor to the pledgee is a kind of term loan. bailment. Therefore, pledge creates some liabilities for the bank. It must take reasonable care of goods pledged with it. The term 'reasonable care' means care which a prudent person would take to protect his property. He would be responsible for any loss or damage if he uses the pledged goods for his own purposes. In case of non-payment of the loans, the bank enjoys the right to sell the goods. Lien : The term 'lien' refers to the right of a party to retain goods belonging to another party until a debt due to him is paid. Lien can be of two types: (i) particular is a publicly lien, and (ii) general lien. Particular lien is a right to retain goods until a claim disclosed legal pertaining to these goods is fully paid. On the other hand, general lien can be claim on applied till all dues of the claimant are paid. Banks usually enjoy general lien. 6 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Mortgage It is the transfer of a legal/equitable interest in specific immovable property for securing the payment of debt. The person who parts with the interest in is the additional the property is called 'mortgagor' and the bank .in whose favour the transfer takes security of place is the 'mortgagee'. The instrument of transfer is called the 'mortgage deed'. Mortgage is, thus, conveyance of interest in the mortgaged property. The mortgage interest in the property is terminated as soon as the debt is paid. Charge Where immovable property of one person is, by the act of parties or by the operation of law, made security for the payment of money to another and the transaction does not amount to mortgage, the latter person is said to have a charge on the property and all the provisions of simple mortgage will apply to such a charge. The provisions are as follows: n A charge is not the transfer of interest in the property though it is security for payment. But mortgage is a transfer of interest in the property. n A charge may be created by the act of parties or by the operation of law. But a mortgage can be created only by the act of parties. n A charge need not be made in writing but a mortgage deed must be attested. BOARD PAPER Q1) Explain the various factors affecting/ influencing working capital . (NOV 02, NOV 05, NOV 04,MAY 2005, MAY 2008) Q2) Distinguish between permanent and temporary working capital (NOV 2001) Q3) What do you understand by permanent and temporary working capital ( MAY 2002) Working capital Illustration .1: Maruti Ltd. had an annual sales of 50 000 units at Rs 100 per unit The Company works for 50 weeks in the year. The cost details of the Company are as given below :Cost elements Unit Cost Rs. Raw Materials 30 Labour 10 Overheads 20 60 Profit per unit 40 Selling price per unit 100 The company has the practice of storing raw materials for 4 weeks requirements. Wages and other expenses are paid after a lag of 2 weeks Further, the debtors enjoy a credit of 10 weeks and company gets a credit of 4 weeks from suppliers. The processing time is 2 7 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

weeks and finished goods inventory is maintained for 4 weeks. From the above information prepare a Working Capital Estimate, allowing for a 15% contingency. Illustration 2 A factory produces 96,000 units during the year and sells them for Rs. 50 per unit. Cost structure of a product is as follows : Raw Materials 60% Labour 15% Overheads 10% 85% Profit 15% Selling Price 100% The following additional information is available: (1) The activities of purchasing, producing and selling occur evenly throughout the year. (2) Raw materials equivalent to 1 months supply is stored in godown. (3) The production process takes 1 month (4) Finished goods equal to three months production are carried in stock. (5) Debtors get 2 months credit. (6) Creditors allow 1 months credit. (7) Time lag in payment of wages and overheads in 1/2 month. (8) Cash and bank balance is to be maintained at 10% of the working capital. (9) 10% of the sales are made at 10% above the normal selling price. Draw a forecast of working capital requirements of the factory. Illustration 3 A factory produces 84,000 units during the year and sells them @ Rs.50 per unit. Cost structure of a product as follows: Raw Materials 55% Labour 18% Overheads 17% 90% Profit 10% Selling Price 100% The following additional information is available : (1) The activities of purchasing, producing and selling occur evenly throughout the year. (2) Raw Materials equivalent to 1 1/2 months supply is stored in godown. (3) The production process takes 15 days. (4) Finished goods equal to one months production are carried in stock. (5) Debtors get 1 month credit. (6) Creditors allow 2 months credit. (7) Time lag in payment of wages and overhead is 1 month. 8 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

(8) Cash & Bank Balance is to be maintained at 15% of the working capital. (9) 25% of purchases are for cash. Draw a forecast of working capital requirements of the factory. Illustration 4 M/s Shailesh Enterprise manufacturers and sells household goods to retailers. The following are the budgeted figures for the year 2001: Rs. Rs. Sales 9 42 480 Raw Materials 3,77,040 Labour 1,85,160 Overheads 1,38,000 7,00,200 Profit 2,42,280 + Additional Information: (1) Raw Materials are carried in stock on an average for two months. (2) Process period is one-half month. (3) Finished goods are carried in stock on an average for one month. (4) Normal credit period allowed to customers is three months. (5) Suppliers of Raw Materials allow two months time. (6) Time lag in payment of labour and overheads one month. (7) Cash on hand and at bank-estimated throughout the year Rs.20,000. (8) The activity is spread over evenly during the year. You are required to estimate the amount of Working Capital from the above information. The Working Capital is to be increased by 10% for contingencies. Assume that all the materials are introduced for processing at a time and labour and overheads are incurred gradually. Illustration 5 :You company is about to commence a subsidiary business and has acquired the necessary fixed assets and you are now required to advise the directors as to the additional amounts which would be required as Working Capital. Following are the estimates for the current year and an overdraft limit of Rs.15,000 has been arranged w the companys bankers. Average period of Estimate for the Current Year Credit Rs. Materials 6 reeks 2,60,000 Wages 1 1/2 weeks 1,95,000 Overheads: - Rent, etc 6 months 10,000 - Salaries - (Manager and Directors) 1 month 36,000 9 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

- Office salaries 2 weeks 45,509 - Travellers Commission 3 months 20,000 - Other overheads 2 months 60,000 Sales: - Cash 14,000 - Credit 7 weeks 6 50 000 Average amount of raw material , finished stock and work-in-progress Rs. 30,000 Average amount of undrawn profits Rs. 31,000 You are required to prepare from the above figures and information, statements for submission to your Directors giving an estimate of the Average Working Capital they should provide for. and how working capital finance should be provided. Illustration 6: Bharat cables Ltd. sells its goods in domestic as well in foreign market Domestic selling prices are 25% gross profit on sales and export prices are 10% below the domestic prices; these prices are without taking depreciation into account in the cost. Following are the estimated annual figures for the next year: Rs. Rs. Sales - Domestic 1,80,000 Export 36.000 2,16,000 Material Consumption 54,000 Wages (time-lag one month) 42,000 Manufacturing Expenses (one month in arrears) 66,000 Depreciation 6,000 Administration expenses (one month in arrears) 60,000 Sales Promotion Expenses (Payable quarterly in advance) 30,000 Companys policy is to maintain one-month stock each of raw materials and finished goods required, and cash Rs.1 0,000. Domestic customers are allowed credit of two months and foreign customers get credit for three months from the date of sale. Two months credit facility is available from the suppliers. Ascertain the funds required as Working Capital on- above estimates, keeping an additional 10 per cent as safety margin. Illustration 7 (NOV 2001): The Board of Directors of Alka Ltd. require you to prepare a statement showing the working capital requirements forecast for a level of activity of 1,56,000 units of production. The following information is available for your calculation: (Rs. Per Unit) Raw-Materials 90 Direct Labour 40 Overheads 75 205 10 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Profit 60 Selling Price Per Unit 265 a. Raw materials are in stock on average one month. b. Materials are in process, on average two weeks. c. Finished goods are in stock, on average one month. d. Credit allowed by suppliers one month. e. Time lag in payment from debtors two months. f. Time lag in payment of wages 1 weeks. g. Lag in payment of overheads one month. 20% of the output is sold against cash. Cash in hand and at Bank is expected to be Rs. 60,000. It is to be assumed that production is carried on evenly throughout the year. Wages and overheads accrue similarly and a time period of 4 weeks is equivalent to a month. Illustration: 8 ( May 2006) From the following information prepare an estimate of working capital required to finance a level of activity of 3,12,000 units p.a. (52 weeks) and how will you finance the working capital. Particulars Per Unit Rs. Raw Materials 90 Wages 40 Overheads: Manufacturing 30 Administrative 40 Selling 10 210 Profit 40 Selling Price 250 Other information: (1) Raw materials are held in stock for a period of 4 weeks. (2) Materials remain in process for 2 weeks requiring 50% wages and 40% overheads. (3) Finished goods remain in stock for a period of 4 weeks (4) Credit allowed to customers is 8 weeks but 20% of the invoice price is collected immediately. (5) Time lag in payment of wages is 1.5 week and in overheads is 4 weeks. (6) Credit available from suppliers is 4 weeks but 20% of the creditors are paid 4 weeks in advance. (7) Bank balance is to e maintained at Rs. 60,000. Illustration: 9 ( May 2004)

11 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Tasty Ltd. is presently operating at 50% level producing 30,000 packets of snack foods and proposes to increase capacity utilization in the coming year by 25% over existing level of production. The following data has been supplied: (i) Unit cost structure of the product at current level: Rs. Raw Material 4 Wages (Variable) 2 Overheads (Variable) 2 Fixed Overhead 1 Profit 3 Selling Price 12 (ii) Raw materials will remain in stores for 1 month before being issued for production. Material will remain in process for further 1 month. Suppliers grant 3 months credit to the company. (iii) Finished goods remain in godown for 1 month. (iv) Debtors are allowed credit for2 months. (v) Lag in wages and overhead payments is 1 month and these expenses accrue evenly throughout the production cycle. (vi) No increase either in cost of Inputs or selling price is envisaged. Prepare an estimate of working capital requirement at the new level, assuming that a minimum cash balance of Rs. 20,000 has to be maintained. Illustration: 10 ( Nov 2006) The following is a cost sheet of a Company producing 48,000 similar types of products every year. Particulars Amount per unit in (Rs.) Raw Materials 80 Labour 40 Factory Overheads 30 Selling and Distribution cost 20 Net Profit 30 The following further particulars are given to you: (1) Raw materials remain in stock for 2 months while finished goods stock in carried for 3 month. (2) Credit allowed to customers is 3 months while credit allowed by suppliers of materials is 2 months. (3) Factory Overheads are paid at the end of the month. (4) Company has a policy to have bank balance of at least Rs. 1,50,000 on any date and cash holding worth 3 months factory overhead. (5) 20% of the total sale is for cash. You are required to prepare a statement of working capital requirements. 12 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Illustration: 11 ( OCT 2008) The selling price of the product is Rs 20/- each and its break up is: Material 40%, Labour 20%, Other cost 10%. General overheads 10%, Selling and distribution cost 10%, profit 10%. A company produces 3,60,000 units of a product in a year are given for consideration: (a) Raw materials remain in stock for 3 months and suppliers of raw material extend 2 month credit. (b) The work in progress is to be valued @ 50%. Of the total direct cost of one month production. (c) The customers are given three months credit. (d) The wages are paid after end of the month. (e) 40% of the sales are of cash and balance for credit. (f) There is no opening and closing stock of finished goods (g) Cash and bank balance is carried to the extent of 50% of a monthly profit on a average basis You are required to determine working capital requirement business. Illustration: 12 ( May 2003) The following data is furnished to you regarding two companies A and B operating in the same industry. A B Raw materials stock (in terms of days purchases) 75 72 Work in process stock (in terms of days of cost of goods sold) 36 30 Finished goods stock (in terms of days of cost of goods sold) 54 40 Average collection period (in days) 72 90 Average Payment Period in days 60 48 (i) Calculate the operating cycle in case of each of the two companies. (ii) Also suggest steps you would take to reduce the operating cycle. (iii) What will be effect of reducing the operating cycle?

Steps to reduce operating working capital cycle Stock holding period of Raw material can improve by following refined inventory management techniques like Just In Time (JIT), Eco Quantity (EOQ) with pre-defined Re-Order levels.

13 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Time lag in input and output can be shortened through mechanization, synchronization between various production processes, effective supervision and control, Incentive based remuneration to workers, better production layout. Finished goods holding period better demand forecasting, warehouses located near markets, effective distribution network supplement by effective marketing policies. Average collection Period- Cautions credit after considering cost benefit analysis. Various collection strategies like prompt billing, regular follow-up and reminders, decentralized collection networks like lockbox, concentration banking and net banking (e-banking). Average payment period- negotiate for better terms and conditions through bulk orders. Illustration: 13 From the following data calculate the working capital cycle for each of the two years and comment on increase / decrease. Assume 360 days in the year. Particulars Stock Raw material Work in progress Finished goods Purchase of Raw material Cost of goods sold Sales Debtors Creditors Year 1 20,000 14,000 21,000 96,000 1,40,00 0 1,60,00 0 32,000 16,000 Year2 27,000 18,000 24,000 1,35,000 1,80,000 2,00,000 50,000 18,000

Working Capital assessment on the formula prescribed by the Tandon Committee OR Maximun Premissible Bank Finance (MPBF). Working Capital Requirement (WCR) = [assets i.e. CA (as per industry norms) Current Liabilities i.e. CL] As per Formula 1: PBF = 75% of [ CA - CL] As per Formula 2: PBF = 75% [CA] - CL As per Formula 3: PBF = [75 %( CA-CCA)] -CL Note: In the above formulaes CL will not include existing Short Term bank borrowings like overdraft/ cash credit.

14 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Core Current Assets i.e. permanent current assets (that means bare minimum level of raw material, work in progress, finished goods and stores to keep the manufacturing process going on) should be financed from long term funds.

Home work section

Illustration 1 The Board of Directors of Century Ltd., requests you to prepare a statement showing the requirements of working capital for a forecast level of activity of 52,000 units in the ensuing year (52 weeks) from the following information made available:Cost Per Unit Rs. Raw Material 400 Direct Labour 150 Overheads Manufacturing 200 Overheads Selling & Distribution 100 Total 850 Additional Information : (1) Selling Price - Rs. 1,000 per unit. (2) Raw material in Stock - Average 4 weeks. (3) Work - in - Progress - Average 4 weeks. (4) Finished Goods in Stock - Average 4 weeks. (5) Credit allowed to Debtors - Average 8 weeks. (6) Credit allowed by Suppliers Average 4 weeks (7) Cash at Bank is expected to be As. 50,000. (8) All sales are on credit basis. (9) All the activities are evenly spread out during the year. (10) Debtors are to be valued at sales. Illustration 2 The Management of German Collaboration Limited has called for a statement showing the working capital needed to finance a level of activity of 3,00,000 units output for the year. The cost structure for the companys product for the said activity level is detailed below: Cost Per Unit (Rs.) Raw Material 20 15 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi

TYBMS: FM

Direct Labour 5 Overheads 15 Total Cost 40 Profit 10 Selling Price 50 (1) Past trend indicates that raw material are held in stock on an average for two months. (2) Work in Progress will approximate to half a months production. (3) Finished goods remain in warehouse on average for a month. (4) Suppliers of materials extend a months credit. (5) Two months credit is normally allowed to debtors. (6) A minimum cash balance of As. 25,000 is expected to be maintained. The production pattern is assumed to be even during the year. Prepare the statement of working capital requirements. Illustration 3 From the following details, prepare an estimate of the requirement of Working Capital: Production 60,000 Units Selling Price per unit Rs.5 Raw Materials 60% of Selling Price Direct Wages 10% of Selling Price Overheads 20% of Selling Price Materials in Hand 2 months requirements Production time 1 month Finished Goods in Stores 3 months Credit for Material 2 months Credit allowed to Customers 3 months Average Cash Balance Rs.20,000 Wages and overheads are paid at the beginning of the month following. In production all the required materials are charged in the initial stage and wages and overheads accrue evenly. Illustration 4. Foods Ltd. is presently operating at 60 per cent level, producing 36,000 packets of snack foods and proposes to increase its capacity utilisation in the coming year by 33.33 per cent over the existing level of production. The following data has been supplied: (i) Unit cost structure of the product at current level: Rs. Raw material 4 Wages (variable) 2 Overheads (variable) 2 Fixed overhead 1 16 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi Profit Selling price 3 12

TYBMS: FM

(ii) Raw materials will remain in stores for 1 month before being issued for production. Material will remain in process for further 1 month. Suppliers grant 3 months credit to the company. (iii) Finished goods remain in godown for 1 month. (iv) Debtors are allowed credit for 2 months. (v) Average time-lag in wages and overhead payments is 1 month and these expenses throughout the production cycle. (vi) No increase either in cost of inputs or selling price is envisaged. Prepare a projected profitability statement and a statement showing working capital requirement at the new level, assuming that a minimum- cash balance of Rs. 19,500 has to be maintained. Illustration 5 Blue Ltd., furnishes the following Income Statement for the year 2001. Rs. Rs. Sales (Credit 2 months) 12,00,000 Purchases (Credit 1 month) 4,00,000 Wages (Credit 1/2 a month) 1,92,000 Factory rent (payable quarterly in advance) 52,000 Factory expenses (1 months credit) 96,000 Office expenses (1 months credit) 12,000 Managing Directors Salary (1 months credit) 48,000 8,00,000 Profit 4,00,000 Additional Information: Average investment in stock of raw materials and work-in-progress is expected to be Rs. 90,000 and Rs. 60,000 respectively. Average investment in stock of finished goods is expected to be Rs. 55,000. You are required to forecast the working capital requirements of the company. Illustration 6 Premier Ltd. is desirous to purchase a business and has consulted you, and one point on which you are asked to advise them is the average amount of working capital which will be required in the first years working. You are given the following estimate and are instructed to add 20% to your computed figures to allow for contingencies. Figure for the Year. 17 Always bear in mind that your own resolution to succeed is more important than any other one thing.

CA.CS.MBA. Naveen, Rohatgi Rs.

TYBMS: FM

(a) Average amount looked up for stocks: 64,000 Stock of Finished Product 4,800 Stocks of Material etc. (b) Average credit given: 6,24,000 Inland Sales - 6 weeks 5,20,000 Export Sales - 2 weeks (c) Lag in payment of wages and other outgoing: 4,29,000 Wages 3 weeks 97,200 Stores, Materials - 2 1/2 weeks 24,000 Rent, Rates & Taxes - 3 months 81,600 Staff - 1/2 month 12,480 (d) Payment in Advance: Sundry Expenses (Paid quarterly in advance) Set up your calculations for the average amount of Working Capital Required.

18 Always bear in mind that your own resolution to succeed is more important than any other one thing.