Estimation of working capital requirement for Financial Management and Policy Mcom sem 2 Delhi University

Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University:-we will provide complete details of Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University in this article.

Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University

Estimation of working capital requirement for Financial Management and Policy Mcom sem 2 Delhi University:-Estimating Working Capital Requirement Method # 1. Percentage of Sales Method:

This method of estimating working capital requirements is based on the assumption that the level of working capital for any firm is directly related to its sales value. If past experience indicates a stable relationship between the amount of sales and working capital, then this basis may be used to determine the requirements of working capital for future period.

Thus, if sales for the year 2007 amounted to Rs 30,00,000 and working capital required was Rs 6,00,000; the requirement of working capital for the year 2008 on an estimated sales of Rs 40,00,000 shall be Rs 8,00,000; i.e. 20% of Rs 40,00,000.

The individual items of current assets and current liabilities can also be estimated on the basis of the past experience as a percentage of sales. This method is simple to understand and easy to operate but it cannot be applied in all cases because the direct relationship between sales and working capital may not be established.

Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University:-Estimating Working Capital Requirement Method # 2. Regression Analysis Method (Average Relationship between Sales and Working Capital):

This method of forecasting working capital requirements is based upon the statistical technique of estimating or predicting the unknown value of a dependent variable from the known value of an independent variable. It is the measure of the average relationship between two or more variables, i.e.; sales and working capital, in terms of the original units of the data.

Estimation of working capital requirement for Financial Management and Policy Mcom sem 2 Delhi University:-Estimating Working Capital Requirement Method # 3. Cash Forecasting Method:

This method of estimating working capital requirements involves forecasting of cash receipts and disbursements during a future period of time. Cash forecast will include all possible sources from which cash will be received and the channels in which payments are to be made so that a consolidated cash position is determined.

This method is similar to the preparation of a cash budget. The excess of receipts over payments represents surplus of cash and the excess of payments over receipts causes deficit of cash or the amount of working capital required.

Estimation of working capital requirement for Financial Management and Policy Mcom sem 2 Delhi University:-Estimating Working Capital Requirement Method # 4. Operating Cycle Method:

This method of estimating working capital requirements is based upon the operating cycle concept of working capital. The cycle starts with the purchase of raw material and other resources and ends with the realization of cash from the sale of finished goods.

It involves purchase of raw materials and stores, its conversion into stock of finished goods through work-in-process with progressive increment of labour and service costs, conversion of finished stock into sales, debtors and receivables, realization of cash and this cycle continues again from cash to purchase of raw material and so on. The speed/time duration required to complete one cycle determines the requirement of working capital – longer the period of cycle, larger is the requirement of working capital and vice-versa.

For proper computation of working capital under this method, a detailed analysis is made for each individual component of working capital.

The value of each individual item of current assets and current liabilities is determined on the basis of estimated sales or budgeted production or activity level as follows:

(a) Stock of Raw Material: The amount of working capital funds to be invested in holding stock of raw material can be estimated on the basis of budgeted units of production, estimated cost of raw material per unit and the average duration for which the raw material is held in stock by using the following formula:

(Note. 360 days in a year may. be assumed in place of 365 to simplify calculations in some cases)

(b) Stock of Work-in-Process:

In manufacturing/processing industries the production is carried on continuous basis. At the end of the period, some work remains incomplete even though all or some expenses have been incurred, this work is known as work-in-progress or partly completed or semi-finished goods. The work-in-process consists of direct material, direct labour and production overheads locked up in these semi­-finished goods.

Estimation of working capital requirement for Financial Management and Policy Mcom sem 2 Delhi University:-Approaches to Estimation of Working Capital Requirements:

While studying the valuation of each individual item of current assets or current liabilities under the operating cycle method, that there are two approaches which are followed in the estimation of working capital requirements:

(a) Total Approach

(b) Cash Cost Approach

(a) Total Approach: Under this approach of estimation of working capital requirements, all costs including depreciation and profit margin are included. Thus, production overhead inclusive of depreciation is considered for calculation of the cost of work-in-progress. In the same manner, cost of goods produced includes depreciation. Further, the computation of funds invested in debtors is done on the basis of selling price including profit margin.

(b) Cash Cost Approach: Under this approach, the amount of working capital is estimated on the basis of only cash costs incurred. Thus, depreciation being non-cash is excluded while calculating the cost of work-in-process, cost of goods produced and cost of goods sold. In the same manner, debtors are computed on the basis of cash cost of sales excluding profit margin.

Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University:-Estimating Working Capital Requirement Method # 5. Projected Balance Sheet Method:

Under this method, projected balance sheet for future date is prepared by forecasting of assets and liabilities by following any of the methods stated above. The excess of estimated total current assets over estimated current liabilities, as shown in the projected balance sheet, is computed to indicate the estimated amount of working capital required.

Estimation of working capital requirement for Financial Management and Policy MCOM sem 2 Delhi University

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