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Computation And Estimation Of Working Capital

COMPUTATION OF WORKING CAPITAL AND ESTIMATION OF WORKING CAPITAL:

Working Capital requirement depends upon number of factors, which are already discussed in the previous parts. Now the discussion is on how to calculate the Working Capital needs of the business concern. It may also depend upon various factors but some of the common methods are used to estimate the Working Capital.

A. Estimation of components of working capital method

Working capital consists of various current assets and current liabilities. Hence, we have to estimate how much current assets as inventories required and how much cash required to meet the short term obligations.

Finance Manager first estimates the assets and required Working Capital for a particular period.

B. Percent of sales method

Based on the past experience between Sales and Working Capital requirements, a ratio can be determined for estimating the Working Capital requirement in future. It is the simple and tradition method to estimate the Working Capital requirements. Under this method, first we have to find out the sales to Working Capital ratio and based on that we have to estimate Working Capital requirements. This method also expresses the relationship between the Sales and Working Capital.

C. Operating cycle

Working Capital requirements depend upon the operating cycle of the business. The operating cycle begins with the acquisition of raw material and ends with the collection of receivables.

finance
[Post Image Courtesy of BPlanet at FreeDigitalPhotos.net]

Operating cycle consists of the following important stages:

1. Raw Material and Storage Stage, (R)

2. Work in Process Stage, (W)

3. Finished Goods Stage, (F)

4. Debtors Collection Stage, (D)

5. Creditors Payment Period Stage. (C)

Thus, Operating cycle (OC) = R + W + F + D–C

Each component of the operating cycle can be calculated by the following formula:

R = Average Stock of Raw Material / Average Raw Material Consumption Per Day

W = Average Work in Process Inventory / Average Cost of Production Per Day

F = Average Finished Stock Inventory / Average Cost of Goods Sold Per Day

D = Average Book Debts / Average Credit Sales Per Day

C= Average Trade Creditors / Average Credit Purchase Per Day

About Author Mohamed Abu 'l-Gharaniq

when an unknown printer took a galley of type and scrambled it to make a type specimen book. It has survived not only five centuries.

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