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
Evaluate the importance of leverage of financial management on a small scale company.

Explain about the liquidity premium theory of the term structure of interest rates. Liquidity premium theory: Liquidity premium theory asserts which, into a world of unce

What is triangular arbitrage?  What is a condition that will give increase to a triangular arbitrage opportunity? Answer:  Triangular arbitrage is the method of trading out of th

Assume that you have been consistently impressed by David and Tom Gardner of The Motley Fool since you first heard of their rather improbable rise to prominence in financial circ

This is the part of after-tax personal income that is not spent.

Have mergers affected competition? A: Federal Reserve data depict that measured on the local level, where competition occurs; markets have in fact experienced more banking comp

Q. Types of financial statement analysis? 1) External analysis This analysis is performed by external stakeholders like lenders, suppliers, investors, and governments. 2)

What are the time dimensions of the income statement, the balance sheet, and the statement of cash flows? Hint: Are they videos or still pictures?  Explain. Sol. The i

Explain the Advantagesand disadvantages of MBO Advantages of MBO Disadvantages of MBO Sale can be arranged quickly   Manag

Evaluate the importance of leverage in financial management of a small scale company