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
Q. Show the Objectives of Inventory Management? Objectives of Inventory Management- The objectives of Inventory Management are: To maintain a adequate large size of inventor

Project Budgets and Reporting Systems: In many cases, where a project is initiated and a budget allocated, a separate account is created to ensure costs attributable to that pr

Q. Drawbacks or Criticism of MM Approach? Risk Perceptions of personal as well as corporate leverages are different: - It is incorrect to presume that 'personal leverage' is a

Calculate the Price of Commonwealth bonds Commonwealth Company has a 10% coupon bond with a par value of $1000, The current yield to maturity on new bonds is 8%. If interest is

Example: - Two firm U as well as L is identical in every respect except that U is unlevered and L is levered. L has Rs. 20Lakh of 8% debt outstanding. The net operating income of b

What is Control risk That material misstatement could take place and not be detected, or prevented on a timely basis, by accounting and internal control systems. All audits

Q. What is Unsanctioned Expenditure? The expenditure, which is regularly incurred without the sanction of the competent authority or beyond the sanctioned limit of funds provid

Which formula would you use to solve for the payment needed for a car loan if you know the interest rate, length of the loan, and the borrowed amount?  Describe. To solve for k

The Federal Minister for the Environment is worried about the Greenhouse Effect, one outcome of which would be that Adelaide would have a subtropical climate by the year 2015. This

Under this approach of Valuation, all cash flows are discounted using single interest rate (discount rate).  For example: Consider the 5-year (7.00 percent) Treas