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
Tests for Consistency The consistency of the index numbers have been tested over the years. The most important of these tests are: The time reversal test The

Q. What is Cash Credit? A cash credit is an arrangement by which a bank allows his customer to borrow money up to a certain limit against some tangible securities or guarantees

A/A2 is generally the second- or third-highest rating that a rating agency gives to a security or carrier. This rating indicates that there is a comparatively low risk of default a

Q. Explain about Inventory Turnover Ratio ? Inventory Turnover Ratio: - Definite items of inventory are slow moving. It signifies that their consumption is quite slow and capit

Q. Describe the Walters dividend model? Walter's Model: - Walter's model maintains the doctrine that the dividend policy is relevant for the value of the firm. As-per to the Wa

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

Explain about opportunity cost of capital Risk free rate compensates for opportunity lost and risk premium compensates for risk. It can also be known as the 'opportunity cost o

Genital and Reproductive Function: J.Y. is a 43-year-old woman who has detected a lump in the upper outer quadrant of her left breast while performing her monthly self-breast

What problems can take place into the capital budgeting analysis if project debt is evaluated in place of the borrowing capacity created by the project? If project debt is grea

Complete the financial reporting for each period and develop recommendations using the templates provided. Procedure 1. Read the case study. 2. Complete the financial reports