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
Participants in Hedge Funds: The Sponsor and the Investors Sponsors are promoters and generally, they hold a profit share on percentage for the capital invested in the Fun

Ivan is making several entries into the general journal at the restaurant where he serves as an accountant. The main difference between entries for routine business transactions an

Q. Consigner for safe transportation of dangerous goods? It is the responsibility of the consigner to ensure the following, 1. The goods carriage should have a valid registr

Rationale for Mergers Many of the motives behind mergers of firms are discussed hereunder: Growth Growth is the most general and important motive for mergers. Merging f

Yield to put is the rate at which the present value of cash flow to the first put date is equal to the price plus interest rate. It is used for

Corrective Action: Once budget figures are compared with those actually achieved, and a variance analysis carried out, management can then take steps to correct any problems id

The main aim of securitization that was initiated in the late sixties was to resolve problems of mismatch and protect the US mortgage financing system from macroe

Determine the Symptoms of overtrading Symptoms of overtrading are:- Fast sales growth Increasing trade payables Increasing trade receivables Fall in cash ba

R eceipt of bids and bid opening We discussed how to prepare the bids and to publish them in the earlier sub section. Now let us see how to receive and open bids. To receiv

P Company manufactures and sells a range of children's clothing through its retail shops and is currently designing a website in order to allow customers to purchase products onlin