Measuring Working Capital

In the previous section we have discussed the factors that influence the quantum of working capital in a business enterprise. Now let us attempt to determine the amount of working capital that an enterprise, say, dairy plant, would need by taking up an illustration.

Illustration Objective: To determine the magnitude of working capital for a newly set up ghee manufacturing unit using given information:

a) The proforma cost sheet provides following particulars:

b) Annual Production is estimated to be 24,000 kgs.

c) Raw material, parts and components are expected to remain in stores for average period of two days.

d) Materials are in process on average one day and at 50% completion stage.

e) Finished goods remain in stock on average 30 days.

f) Credit allowed by suppliers is 30 days.

g) Credit allowed to debtors is 60 days. Half of the sales are likely to be on credit.

h) Average time lag in payment to labour is 15 days and 30 days in overhead & fuel expenses.

i) Assume that sales and production follow a consistent pattern.

j) 10% of the computed figure is kept for buffer cash and contingencies. Solution:

Working notes: (a) The yearly production is 24,000kg., half of the sales are on credit, therefore, 12,000 kg. are sold on credit and 12,000 kg. on cash.

(b) Amount locked up in stock of raw material = (Annual production x Unit raw material cost x period for which stock required)/No. of days in year.

(c) Work in process stock = {(Annual production x Unit raw material or labour or overhead cost x period for which stock required)/No. of days in year}x 50%(because work in progress is assumed to be at 50% completion stage).

(d) Cost of finished good = (Annual production x Unit cost of finished good x period for which stock held)/No. of days in year.

(e) Debtors = (Credit sales x Selling Price x period of credit)/No. of days in year.

(f) Creditors for purchase of raw material = (Annual production x Unit raw material cost x period for which credit available)/No. of days in year.

(g) Av. lag in payment of labour = (Annual production x Unit labour cost x lag period for payment)/No. of days in year.

(h) Av. lag in payment of overhead = (Annual production x Unit overhead cost x lag period for payment)/No. of days in year.

Statement showing determination of net working capital.