Ch 13 WorkingC M An Overview

8/3/2019 Ch 13 WorkingC M An Overview

1/40

Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management

Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management 13-13-11

13-13-11

Chapter 13Chapter 13

Working CapitalWorking Capital

Management An OverviewManagement An Overview


2/40



13-13-22

WORKING CAPITALWORKING CAPITAL

MANAGEMENT AN OVERVIEWMANAGEMENT AN OVERVIEW

Nature of Working Capital

Management of Working Capital in

India

Planning of Working Capital

Solved Problem

Mini Case


3/40



13-13-33

NATURE OF WORKING CAPITAL

Working capital management is concerned with the problems that arise in managingthe current assets (CA), current liabilities (CL) and the interrelationships between them.Its operational goal is to manage the CA and CL in such a way that asatisfactory/acceptable level of net working capital (NWC) is maintained.

Concepts and Definitions of Working Capital There are two concepts of working capital:

1) Gross and2) Net

Gross Working Capital

Gross working capital means the current assets which represent the proportion ofinvestment that circulates from one form to another in the ordinary conduct of business.

Net Working Capital The term net working capital can be defined in two ways:1) the most common definition of net working capital (NWC) is the difference

between current assets and current liabilities; and2) alternate definition of NWC is that portion of current assets which is financed with

long-term funds.


4/40



13-13-44

The task of the financial manager in managing working capital efficiently is to ensure sufficientliquidity in the operations of the enterprise. The liquidity of a business firm is measured by itsability to satisfy short-term obligations as they become due. The three basic measures of afirms overall liquidity are

1) the current ratio,2) the acid-test ratio, and

3) the net working capital

The Common Definition of NWC and its Implications

The NWC is necessary due to non-synchronous nature of expected cash inflowsand required cash outflows. The more predictable the cash inflows are, the lessNWC will be required and vice-versa.


5/40



13-13-55

Determining Financing Mix

Financing mix is the choice of sources of financing of current assets.

There are three basic approaches to determine an appropriate financing mix:

1) Hedging approach, also called the Matching approach;2) Conservative approach, and

3) Trade-off between these two.

(a) Hedging Approach

The term hedging is often used in the sense of a risk-reducing investment strategy involving

transactions of a simultaneous but opposing nature so that the effect of one is likely tocounterbalance the effect of the other. This approach to the financing decision to determine

an appropriate financing mix is, therefore, also called as Matching approach.

According to this approach, the maturity of the source of funds should match the nature of the

assets to be financed. For the purpose of analysis, the current assets can be broadlyclassified into two classes:

1. those which are required in a certain amount for a given level ofoperation and, hence, do not vary over time.

2. those which fluctuate over time.


6/40



13-13-66

TABLE 1 Estimated Total Funds Requirements of Hypothetical Ltd(Amount in Rs lakh)

Month Total fundsrequired

Permanentrequirements

Seasonalrequirements

(1) (2) (3) (4)January Rs 8,500 Rs 6,900(minimum

amount required inany month)

Rs 1,600

February 8,000 6,900 1,100

March 7,500 6,900 600April 7,000 6,900 100

May 6,900 6,900 0

June 7,150 6,900 250

July 8,000 6,900 1,100

August 8,350 6,900 1,450

September 8,500 6,900 1,600

October 9,000 6,900 2,100

November 8,000 6,900 1,100

December 7,500 6,900

60011,600


7/40 Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management 13-13-7713-13-77

According to the hedging approach, the permanent portion of funds required (Col.3) should be

financed with long-term funds and the seasonal portion (Col.4) with short-term funds. With this

approach, the short-term financing requirements (current assets) would be just equal to the short-

term financing available (current liabilities).

Permanent Needs

Permanent needs implies financing needs for fixed assets plus the permanent portion of current

assets which remain unchanged over the year

Seasonal Portion

Seasonal portion implies the financing requirements for temporary current assets which vary overthe year.

(b) Conservative Approach

This approach suggests that the estimated requirement of total funds should be met from long-term sources; the use of short-term funds should be restricted to only emergency situations orwhen there is an unexpected outflow of funds.

In the case of the Hypothetical Ltd in Table 1, the total requirements, including the entire Rs

9,000 needed in October, will be financed by long-run sources. The short-term funds will be usedonly to meet contingencies. The amounts given in column 4 of Table 1 represent the extent towhich short-term financial needs are being financed by long-term funds, that is, the NWC. TheNWC reaches the highest level (Rs 2,100) in October (Rs 9,000 Rs 6,900). Any long-termfinancing in excess of Rs 6,900 in permanent financing the needs of the company representsNWC.


8/40

Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management Tata McGraw-Hill Publishing Company Limited, Financial Management 13-13-8813-13-88

Comparison of Hedging Approach with Conservative Approach

A comparison of the two approaches can be made on the basis of

1) Cost considerations, and

2) Risk considerations.

(1) Cost ConsiderationsThe cost of these financing plans has a bearing on the profitability of theenterprise. We assume that the cost of short-term funds and long-term funds is3 per cent and 8 per cent respectively.

Hedging Plan The cost of financing under the hedging plan can be estimated as follows:

1) Cost of short-term funds: The cost of short-term funds = average annualshort-term loan x interest rate.

Average annual short-term loan = total of monthly seasonal requirements(Col.4)(see slide 6th) divided by the number of months.

Average annual short-term loan = Rs 11,600 lakh 12 = Rs 966.67 lakh.

Short-term cost = Rs 966.67 lakh 0.03(check lines in black)= Rs 29 lakh.

2) Cost of long-term funds = (Average annual long-term fund requirement)

(annual interest rate) = Rs 6,900 lakh(minimum requirement every month) 0.08 = Rs552 lakh.

3) Total cost under hedging plan = total of (i) + (ii) = Rs 29 lakh + Rs 552 lakh

= Rs 581 lakh


9/40


(2) Risk Considerations s

The two approaches can also be contrasted on the basis of the risk

involved.

Hedging ApproachThe hedging approach is more risky in comparison to the conservative approach.

There are two reasons for this. First, there is, as already observed, no NWC with

the hedging approach because no long-term funds are used to finance short-term

seasonal needs, that is, current assets are just equal to current liabilities. On the

other hand, the conservative approach has a fairly high level of NWC. Secondly,

the hedging plan is risky because it involves almost full utilisation of the capacity to

use short-term funds and in emergency situations it may be difficult to satisfy the

short-term needs.

Conservative Approach

With the conservative approach, in contrast, the company does not use any of its

short-term borrowings. Therefore, the firm has sufficient short-term borrowing

capacity to cover unexpected financial needs and avoid technical insolvency.


10/40


(c) A Trade-off between the Hedging and Conservative

Approaches

It has been shown that the hedging approach is associated with

high profits as well as high risk, while the conservative approach

provides low profits and low risk. Obviously, neither approach by

itself would serve the purpose of efficient working capitalmanagement. A trade-off between these two extremes would

give an acceptable financing strategy. The third approachtrade-

off between the two approachesstrikes a balance and provides a

financing plan that lies between these two extremes.

Acceptable financing strategy is a trade-off between matching and

conservative financing strategies.


11/40


TABLE 2 Trade-off between Hedging and Conservative Approaches

(Amount in Rs Lakh)

Month Total fundsrequired

Permanentrequirements

Seasonalrequirements

(1) (2) (3) (4)

JanuaryFebruaryMarchAprilMayJuneJulyAugustSeptemberOctoberNovember

December

Rs 8,5008,0007,5007,0006,9007,1508,0008,3508,5009,0008,000

7,500

Rs 7,9507,9507,9507,9507,9507,9507,9507,9507,9507,9507,950

7,950

Rs 550500000

50400550

1,05050

02,700

The figures in Table 2 reveal that the maximum fund required is Rs 9,000 lakh(October) and the minimum is Rs 6,900 lakh (May). The average [(Rs 9,000 lakh + Rs6,900) / 2]= Rs 7,950 lakh.


12/40


Cost of the Financing Plan under the Trade-off Approach

1) Cost of short-term funds = (Average annual short-term funds

required) (Rate of short-term interest) = Rs 2,700 lakh/12

= Rs 225 lakh 0.03 = Rs 6.75 lakh

2) Cost of long-term funds = (Average long-term funds required)

(Rate of interest on long-term funds) = Rs 7,950 lakh

0.08 = Rs 636 lakh3) Total cost of the trade-off plan = Rs 6.75 lakh + Rs 636 lakh

= Rs 642.75 lakh

Risk Consideration

The NWC under this plan would be Rs 1,050 lakh (Rs 7,950 lakh Rs

6,900 lakh).


13/40


Comparison of the Trade-off Plan with the Hedging and Conservative Approaches

TABLE 3 Comparision of Trade-off Plan (Amount in Rs Lakh)

Financing Plan Maximum NWC* Degree of risk Total cost offinancing

Level of profits

(1) (2) (3) (4) (5)

Hedging 0 Highest Rs 581.00 Highest

Trade-off Rs 1,050 Intermediate 642.75 IntermediateConservative 2,100 Lowest 720.00 Lowest

*The minimum level would be zero in each case.

Interpretation

From the summary of results in Table 3, it can be seen clearly that the hedging approach is

the most risky while the conservative approach is the least risky. The trade-off plan stands

midway; less risky than the hedging approach but more risky than the conservative approach.

The measure of risk is the level of NWC.


14/40


Planning of Working CapitalPlanning of Working Capital

The need for working capital (WC) arises from the cash/operating cycle

of a firm. It refers to the length of time required to complete the following

sequence of events: conversion of cash into inventory, inventory into

receivables and receivables into cash. The operating cycle creates the

need for working capital and its length in terms of time-span required to

complete the cycle is the major determinant of the firms working capital

needs.


15/40


In other words, the term cash cycle refers to the length of time necessaryto complete the following cycle of events:

1) Conversion of cash into inventory;

2) Conversion of inventory into receivables;3) Conversion of receivables into cash.

The operating cycle, which is a continuous process, is shown in Fig. 1.

Cash

Receivables

Inventory

Phase 3

Phase 1

Phase 2

Figure1: Operating Cycle


16/40


Working capital can be

1) Permanent and

2) Temporary

Permanent (fixed) Working Capital

Permanent working capital is a certain minimum level of working capital on acontinuous and uninterrupted basis.

Temporary (fluctuating/variable) Working Capital

Temporary (fluctuating/variable) working capital is the working capitalneeded to meet seasonal as well as unforeseen requirements.

In the case of an expanding firm, the permanent working capital line may not behorizontal. This is because the demand for permanent current assets might beincreasing (or decreasing) to support a rising level of activity. In that case the linewould be a rising one as shown in Fig. 3.

Both kinds of working capital are necessary to facilitate the sales process throughthe operating cycle. Temporary working capital is created to meet liquidityrequirements .


17/40


Amountof

Workin

gCapital

Figure 2: Permanent and Temporary Working Capital

Temporary

Permanent

Time

Amo

untof

Workin

gCapital

Figure 3: Permanent and Temporary Working Capital

Temporary or

fluctuating

Permanent

Time


18/40


Changes in Working Capital

The changes in the level of working capital occur for the following three basicreasons:

1) Changes in the level of sales and/or operating expenses,

2) Policy changes, and3) Changes in technology.

(1) Changes in Sales and Operating Expenses

The first factor causing a change in the working capital requirement is a change in thesales and operating expenses. The changes in this factor may be due to threereasons: First, there may be a long-run trend of change. In the second place, cyclicalchanges in the economy leading to ups and downs in business activity influence thelevel of working capital, both permanent and temporary. The third source of change isseasonality in sales activity.

The change in sales and operating expenses may be either in the form of an increaseor decrease. An increase in the volume of sales is bound to be accompanied by

higher levels of cash, inventory and receivables. The decline in sales has exactly theopposite effecta decline in the need for working capital. A change in the operatingexpensesrise or fallhas a similar effect on the levels of working capital.


19/40


(2) Policy Changes

The second major cause of changes in the level of working capital is

because of policy changes initiated by the management. The term current

asset policy may be defined as the relationship between current assets andsales volume. A firm following a conservative policy in this respect having a

very high level of current assets in relation to sales may deliberately opt for a

less conservative policy and vice versa.

(3) Technological Changes

Finally, technological changes can cause significant changes in the level of

working capital. If a new process emerges as a result of technological

developments, which shortens the operating cycle, it reduces the need for

working capital and vice versa.


20/40


Determinants of Working Capital

Working capital requirements are determined by a variety of factors. These factors, however,affect different enterprises differently. In general, the factors relevant for proper assessmentof the quantum of working capital required are:

General Nature of BusinessEnterprises fall into some broad categories depending on the nature of their business. For

instance, public utilities, The two relevant features are: (i) the cash nature of business, that is,cash sale, and (ii) sale of services rather than commodities. In view of these features, they donot maintain big inventories and have, therefore, probably the least requirement of workingcapital. At the other extreme are trading and financial enterprises. The nature of theirbusiness is such that they have to maintain a sufficient amount of cash, inventories and bookdebts. They have necessarily to invest proportionately large amounts in working capital.

Production Cycle

Another factor which has a bearing on the quantum of working capital is the production cycle.The term production or manufacturing cycle refers to the time involved in the manufacture of

goods. It covers the time-span between the procurement of raw materials and the completionof the manufacturing process leading to the production of finished goods. Funds have to benecessarily tied up during the process of manufacture, necessitating enhanced workingcapital.


21/40


Business Cycle

The working capital requirements are also determined by the nature of the business

cycle. Business fluctuations lead to cyclical and seasonal changes which, in turn,

cause a shift in the working capital position, particularly for temporary working capitalrequirements. The variations in business conditions may be in two directions: (i)

upward phase when boom conditions prevail, and (ii) downswing phase when

economic activity is marked by a decline. During the upswing of business activity, the

need for working capital is likely to grow to cover the lag between increased sales and

receipt of cash as well as to finance purchases of additional material to cater to the

expansion of the level of activity. Additional funds may be required to invest in plant

and machinery to meet the increased demand. The downswing phase of the business

cycle has exactly an opposite effect on the level of working capital requirement.

Production Policy

The quantum of working capital is also determined by production policy. In the case of

certain lines of business, the demand for products is seasonal, that is, they are

purchased during certain months of the year.


22/40


Credit Policy

The credit policy relating to sales and purchases also affects the working capital. Thecredit policy influences the requirement of working capital in two ways:

1) through credit terms granted by the firm to its customers/buyers of goods;

2) credit terms available to the firm from its creditors.

The credit terms granted to customers have a bearing on the magnitude of workingcapital by determining the level of book debts. The credit sales result in higher bookdebts (receivables). Higher book debts mean more working capital. On the other hand,if liberal credit terms are available from the suppliers of goods (trade creditors), the

need for working capital is less.Growth and Expansion

As a company grows, it is logical to expect that a larger amount of working capital isrequired.

Vagaries in the Availability of Raw Material

To meet vagaries in the unavailability, a firm should have excess inventory of rawmaterials to sustain smooth production. Such a firm would tend to have high level ofWC.

P fi L l


23/40


Profit Level

Cash profit, per-se, should not be viewed as a source of financing WC. Theactual availability of such funds would depend upon the firms requirementfor payment of dividend, payment of loan instalment, creation of sinkingfund, purchase of fixed assets, and so on. In case these requirements are

substantial, cash profit is not likely to be available to meet the needs of afirm. Alternatively, only adjusted cash profits after provisioning for theserequirements should be reckoned for WC financing.

Level of Taxes

The first appropriation out of profits is payment or provision for tax. The amount oftaxes to be paid is determined by the prevailing tax regulation. Very often, taxes haveto be paid in advance on the basis of the profit of the preceding year. Tax liability is, ina sense, short-term liability payable in cash. An adequate provision for tax paymentsis, therefore, an important aspect of working capital planning. If tax liability increases,it leads to an increase in the requirement of working capital and vice versa.

Dividend PolicyAnother appropriation of profits which has a bearing on working capital is dividendpayment. The payment of dividend consumes cash resources and, thereby, affectsworking capital to that extent. Conversely, if the firm does not pay dividend but retainsthe profits, working capital increases.


24/40


Depreciation Policy

Depreciation policy also exerts an influence on the quantum of workingcapital. Depreciation charges do not involve any cash outflows. The effect ofdepreciation policy on working capital is, therefore, indirect.

Higher depreciation (enhanced rates of depreciations) has a positive impacton WC for two reasons: (i) lower tax liability and, hence, more cash profitsand (ii) lower disposable profits and, therefore, a smaller dividend payment.They imply more cash with a corporate.

Price Level Changes

Changes in the price level also affect the requirements of working capital.Rising prices necessitate the use of more funds for maintaining an existinglevel of activity. For the same level of current assets, higher cash outlays arerequired. The effect of rising prices is that a higher amount of working capital

is needed.

Operating Efficiency

Efficiency of operations accelerates the pace of cash cycle andimproves the WC turnover resulting in reduced requirement of WC.


25/40


Computation of Working Capital

A firm should have adequate WC to support its budgeted level of activity in terms of

production/sales. It should have neither more nor less WC than required. While the

excessive WC adversely affects its profits, the inadequate WC interrupts its smoothoperations. Therefore, its correct computation is an important constituent of efficient

WC management.

The relevant factors are the holding periods of the various types of inventories,

debtors collection period, creditors payment period, budgeted yearly production/sales,

cost of goods produced, cost of sales, average time-lag in payment of wages andother overheads, minimum cash balances and so on.

Working capital requirements are to be computed with reference to cash costs

(excluding depreciation) and not the sale price as depreciation is a non-cash cost and,

hence, does not need WC. The investment required to finance debtors are at costprice. The cash cost approach is appropriate to determine WC requirement of a firm.


26/40


Estimation of Current Assets: Raw Materials Inventory The investment in raw materialsinventory is estimated on the basis of Eq. 1.

Budgeted production(in units)

Cost of raw material(s)per unit

Average inventoryholding period(months/days)

12 months/365 days

Work-in-Process (W/P) Inventory The relevant costs to determine work-in-processinventory are the proportionate share of cost of raw materials and conversion costs(labour and manufacturing overhead costs excluding depreciation). In case, full unit of

raw material is required in the beginning, the unit cost of work-in-proess would behigher, that is, cost of full unit + 50 per cent of conversion cost, compared to the rawmaterial requirement throughout the production cycle; W/P is normally equivalent to 50per cent of total cost of production. Symbolically,

Budgeted production(in units)

Estimated work-in-process cost

per unit

Average time spanof work-in-progress

inventory (months/days)

12 months/365 days


27/40


Finished Goods Inventory

Working capital required to finance the finished goods inventory is given by factors

summed up in Eq. 3.

Budgeted

production

(in units)

Cost of goods produced

per unit (excluding

depreciation)

Finished goods

holding period

(months/days)

12 months/365 days

Debtors

The WC tied up in debtors should be estimated in relation to total cost price (excluding

depreciation) Symbolically,

Budgeted

credit sales

(in units)

Cost of sales per

unit excluding

depreciation

Average debt

collection period

(months/days)

12 months/365 days

C h d B k B l


28/40


Trade Creditors

Budgeted yearlyproduction(in units)

Raw materialcost

per unit

Credit periodallowed by creditors

(months/days)

12 months/365 days

Note: Proportional adjustment should be made to cash purchases of raw materials.

Direct Wages

Budgeted yearlyproduction(in units)

Direct labour cost per unit

Average time-lag inpayment of wages

(months/days)

12 months/365 days

Cash and Bank Balances

Apart from WC needs for financing inventories and debtors, firms also find it useful to havesome minimum cash balances with them.

Estimation of Current Liabilities

The working capital needs of business firms are lower to the that extent such needs are metthrough the current liabilities (other than bank credit) arising in the ordinary course of business.The important current liabilities (CL), in this context are, trade-creditors, wages and overheads:


29/40


Overheads (Other Than Depreciation and Amortisation)

Budgeted yearlyproduction

(in units)

Overhead costper unit Average time-lag inpayment of overheads

(months/days)

12 months/365 days

The amount of overheads may be separately calculated for different types of

overheads. In the case of selling overheads, the relevant item would be sales volumeinstead of production volume.

The computation of working capital is summarised in format 1.

The average credit period for the payment of wages approximates to a half-a-month in

the case of monthly wage payment: The first days monthly wages are paid on the 30th

day of the month, extending credit for 29 days, the second days wages are, again, paid

on the 30th, extending credit for 28 days, and so on. Average credit period

approximates to half-a-month.

FORMAT 1 Determination of Working Capital


30/40


FORMAT 1 Determination of Working Capital

(I) Estimation of Current Asset: Amount

(a) Minimum desired cash and bank balances

(b) Inventories

Raw material

Work-in-process

Finished Goods

(c) Debtors*

Total Current Assets

(II) Estimation of Current Liabilities:

(a) Creditors**

(b) Wages

(c) Overheads

Total Current Liabilities

(III)Net Working Capital (I II)Add margin for contingency

(IV)Net Working Capital Required

*If payment is received in advance, the item would be listed in CL.

**If advance payment is to be made to creditors, the item would appear under CA. The samewould be the treatment for advance payment of wages and overheads.

MANAGEMENT OF WORKING CAPITAL IN INDIA


31/40


MANAGEMENT OF WORKING CAPITAL IN INDIA

Indian corporates seem to have adequate and satisfactory level of working capital as reflected in theirliquidity ratios. The foreign controlled companies are placed in a better position relative to the domesticcompanies.

There are wide inter-industry variations in the liquidity ratios of the corporate enterprises. With theexception of sugar, all other industry groups have safe and satisfactory liquidity position.

The majority of Indian companies maintains relatively lower cash/bank balances. Marketable securitiesare yet to emerge as a popular means of cash management. The excess cash is deployed to retireshort-term debt/in short-term bank deposits.

In spite of the notable decline over the years, inventory consitutes a sizeable part of the total currentassets of the Indian corporates. The most important objective of inventory management in India isavoid loss of production/sales. The popular control techniques are ABC, FSN and SDE and inventoryturnover ratio and comparison with competitors are widely used to assess the performance of inventorymanagement.

Debtors/receivables also constitute a significant component of current assets. growth in sales is themost important objective of credit policy and the open credit with approval if exceeds a specified limit isthe most favoured policy. It is common practice to prepare ageing schedule of debtors to assess thefinancial health of the customers before granting credit and monitoring purposes. To speed upcollections, the corporates offer cash discount. The majority of the companies also charge penalinterest.

Accounts payable and short-term loans/advances are the major components of current liabilities. The length of the operating cycle is the most widely use method to determine working capital need.

The working capital financing policy is based on the matching approach. The majority of the companieshave occasionally experienced working capital shortage due mainly to excess inventory accumulationand poor debt collection.


32/40


SOLVED PROBLEMSOLVED PROBLEM

While preparing a project report on behalf of a client you have collected the following facts.


33/40


e p epa g a p oject epo t o be a o a c e t you a e co ected t e o o g actsEstimate the net working capital required for that project. Add 10 per cent to your computed figureto allow contingencies:

Particulars Amount per unit

Estimated cost per unit of production:

Raw materialDirect labourOverheads (exclusive of depreciation, Rs 10 per unit)Total cash cost

Rs 803060

170

Additional information:

Selling price, Rs 200 per unitLevel of activity, 1,04,000 units of production per annumRaw materials in stock, average 4 weeksWork in progress (assume 50 per cent completion stage in respect of conversion costs and 100per cent completion in respect of materials), average 2 weeksFinished goods in stock, average 4 weeksCredit allowed by suppliers, average 4 weeks

Credit allowed to debtors, average 8 weeksLag in payment of wages, average 1.5 weeksCash at bank is expected to be, Rs 25,000.

You may assume that production is carried on evenly throughout the year (52 weeks) and wagesand overheads accrue similarly. All sales are on credit basis only.


34/40


Solution

Net working capital estimate of a project

(A) Current assets:

(i) Raw materials in stock, (1,04,000 Rs 80 4/52) Rs 6,40,000

(ii) Work-in-progress

(a) Raw material (1,04,000 Rs 80 2/52) 3,20,000

(b) Direct Labour (1,04,000 Rs 15 2/52) 60,000

(c) Overheads (1,04,000 Rs 30 2/52) 1,20,000

(iii) Finished goods stock: (1,04,000 Rs 170 4/52) 13,60,000

(iv) Debtors: (1,04,000 Rs 170 8/52) 27,20,000

(v) Cash at bank 25,000

Total investment in current assets 52,45,000

(B) Current liabilities:

(i) Creditors, average 4 weeks: (1,04,000 Rs 80 4/52) 6,40,000

(ii) Lag in payment of wages (1,04,000 Rs 30 1.5/52) 90,000


35/40


Working Notes

A full unit of raw material is required at the beginning of the manufacturing

process and, therefore, total cost of the material, that is, Rs 80 per unit has

been taken into consideration, while in the case of expenses, viz. direct labour

and overheads, the unit has been finished only to the extent of 50 per cent.

Accordingly, Rs 15 and Rs 30 have been charged for direct labour andoverheads respectively in valuing work-in-process.


36/40


MINI CASEMINI CASE

Strong Cement Company Ltd has an installed capacity of producing 1 25 lakh tonnes


37/40


Strong Cement Company Ltd has an installed capacity of producing 1.25 lakh tonnesof cement per annum; its present capacity utilisation is 80 per cent. The major rawmaterial to manufacture cement is limestone which is obtained from the company'sown mechanised mine located near the plant. The company produces cement in 200kgs bags. From the information given below, determine the net working capital (NWC)

requirement of the company for the current year.

Cost structure per bag of cement (estimated)

GypsumLimestone

CoalPacking materialDirect labourFactory overheads (including depreciation of Rs 10)Administrative overheadsSelling overheads

Total cost

Profit marginSelling price

Add: Sale tax (10 per cent of selling price)Invoice price to consumers

Rs 2515

301050302025

205

4525025

275


38/40


Additional information:

1) Desired holding prriod of raw materials: Gypsum, 3 months, Limestone, 1 month,

Coal, 2.5 months, and Packing material, 1.5 months

2) The product is in process for a period of 0.5 month (assume full units of

materials, namely gypsum limestone and coal are required in the beginning;

other conversion costs are to be taken at 50 per cent).

3) Finished goods are in stock for a period of 1 month before they are sold.

4) Debtors are extended credit for a period 3 months.

5) Average time lag in payment of wages is approximately 0.5 month and of

overheads, 1 month.

6) Average time lag in payment of sales tax is 1.5 months.

7) The credit period extended by various suppliers are:

Gypsum, 2 months, Coal, 1 month, and Packing material,

0.5 month.1) Minimum desired cash balance is Rs 25 lakh.

You may state your assumptions, if any.


39/40


SOLUTION

Statement showing determination of net working capital of Strong Cement Company Ltd

Current assets:

Minimum desired cash balance

Raw materials:

Gypsum (5 lakh bags1 Rs 25 3/12)

Limestone (5 lakh bags Rs 15 1/12)

Coal (5 lakh bags Rs 30 2.5/12)

Packing material (5 lakh bags Rs 10 1.5/12)Work-in-process: (5 lakh bags Rs 115 1/24)

Raw material cost 100 per cent (Rs 25 + Rs 15 + Rs 30)

Other conversion costs (Rs 50 + Rs 20 cash factory

overheads + Rs 20) 0.5

Finished goods (5 lakh bags Rs 170** 1/12)Debtors (5 lakh bags Rs 220** 3/12)

Total

Rs 70

45

115

Rs 25,00,000

31,25,000

6,25,000

31,25,000

6,25,00023,95,833

70,83,3332,75,00,000

4,69,79,166


40/40

1313 40401313 4040

Current liabilities:

Creditors:

Gypsum (5 lakh bags Rs 25 2/12)

Coal (5 lakh bags Rs 30 1/12)Packing material (5 lakh bags Rs 10 1/24)

Wages (5 lakh bags Rs 50 1/24)

Overheads (5 lakh bags Rs 65 1/12)

Sales tax (5 lakh bags Rs 25 1.5/12)

TotalNWC

20,83,333

12,50,0002,08,333

10,41,667

27,08,333

15,62,500

88,54,1663,81,25,000

*1.25 lakh tons 0.8 = 1 lakh ton/200 kgs = 5,00,000 bags

**(Total cost, Rs 205 Depreciation, Rs 10 selling overheads, Rs 25)

***(Cash cost, Rs 195 + sale tax, Rs 25)

Date post:	07-Apr-2018
Category:	Documents
Upload:	nehagupta1492
View:	214 times
Download:	0 times

Ch 13 WorkingC M An Overview

Documents