Estimating working capital requirements, Financial Management

ESTIMATING WORKING CAPITAL REQUIREMENTS

To facilitate, estimate the extent of working capital requirement of a firm, various factors are to be considered. There are various methods for estimating the working capital requirements of a firm.  They contain -

i)  Estimation of components of working capital method,

ii)  Percent of sales method and

iii)  Operating cycle method

1. Estimation of components of working capital method

As the concept of net working capital relates to the variation between current assets and current liabilities, estimation of both may provide the potential working capital requirement of the firm.

2. Percent of sales method

According to Percent of sales method, based on the past data, the relationship between sales and working capital is found out and expressed as a ratio.  The calculation and application of this ratio on estimated future sales will give the extent of working capital requirements of the firm.

3. Operating cycle method

Operating cycle is the time duration required to convert sales, after the conversion of resources into inventories and cash.  The  operating  cycle of a manufacturing co involves 3 segments -

i)  acquisition of resources like  raw labor, material, fuel and power 

ii) manufacture of the product that includes conversion of raw material into  work  in  process  and into finished goods, and

iii) sales of the product either for cash or credit.  Credit sales create book debts for collection (debtors).

The length  of  the  operating  cycle  of a  manufacturing co  is  the  sum  of - i)   inventory conversion period (ICP) and ii)   Book debts conversion period (BDCP). collectively, they are sometimes called as gross operating cycle (GOC). GOC = ICP + DCP

The Inventory conversion period is the entire time needed for producing and selling the product and includes - (a) raw material conversion time (RMCP), (b) work in process conversion period (WIPCP) and (c)  Finished good conversion period (FGCP).

ICP = RMCP + WIPCP + FGCP

The payables deferral period (PDP) is the length of time the firm is capable to defer payments on various resource purchases. The variation between the gross operating cycle and payables deferrals period is the net operating cycle (NOC).

NOC = GOC- Payables deferral period.

Posted Date: 10/16/2012 1:27:40 AM | Location : United States







Related Discussions:- Estimating working capital requirements, Assignment Help, Ask Question on Estimating working capital requirements, Get Answer, Expert's Help, Estimating working capital requirements Discussions

Write discussion on Estimating working capital requirements
Your posts are moderated
Related Questions
Credit enhancement of an asset-backed security implies the existence of support for one or more of the bondholders in the structure. Credit enhancement levels var

Fundamental ingredients of Management of working capital Management of working capital has two fundamental ingredients: (1) an overview of working capital management as a wh

Q. Disadvantage or redundancy of excessive working capital? Excessive working capital means idle funds which earns no profit for the business operation it should have nighters

Based on the period involved in repayment of the debt obligations, the debt instruments could be classified into long-/medium-/short-term debt instruments.

Rights of Investors CERTIFICATES An investor is entitled to receive shares/unit certificates allotted to him within a period of 6 weeks from the date of closure of the sub

If dividends paid to common stockholders are not legal obligations of a corporation, is the cost of equity zero? Explain your answer. Even though common stockholders don't have

Why investment decision depend on financing decision All these decisions interact, investment decision cannot be taken without taking the financing decision, working capital de

Q. Describe about Self-Employment Tax? Self-Employment Tax - Most individuals who are in business for themselves, like PARTNERS, SOLE PROPRIETORS or independent contractor ar

Rate of return of a Bond In case of bonds, rather than dividends, investor is entitled to payments of interest yearly or semi-annually. Investor also benefits if there is an ap

Debenture A kind of debt instrument that is not secured by physical any asset or collateral is known as debenture. Debentures are backed by the general creditworthiness and sta