Chapter 11: Working Capital Management

1. Introduction
Before devoting a lot of pages to the topic “working capital management”, I would like to present
some situations before you. Let us have a look:
1. In our houses, a minimum cash balance is always there;
2. Our mothers kneed some extra dough daily and prepare some extra chapattis more than the
requirement;
3. While going out our parents give us extra money other than the fare, staying charges, food
charges, etc.;
4. In businesses extra cash or inventory is always there;
In all the above instances there is a common point—either there is some quantity is locked in or we
have more quantity than the requirements.

2. Meaning/definition of working capital

In reality the ‘more’ which we have discussed above, is called working capital in the business. And in
business this working capital is in the form of cash, stock, debtors, etc.
The basic definition of working capital is: 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙=𝐶𝑢𝑟𝑟𝑒𝑛𝑡𝑠 𝑎𝑠𝑠𝑒𝑡𝑠−𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠.
Other definitions are also there and they are referred to as the concepts. There are two concepts—
1. Gross concept
2. Net concept

2.1. Gross concept

According to the gross concept, all current assets are termed as working capital.

2.2. Net concept

According to the net concept, the working capital is defined as—that part of current assets which has
been financed with the help of long-term funds.
So, we can say that the working capital is the difference of current assets and current liabilities. In
the form of equation—
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Now what are current assets and current liabilities? Current assets are those assets which are
convertible in to cash automatically or by management within the operating cycle. Current liabilities
are those liabilities which are to be repaid within the operating cycle.

3. Types of working capital

Working capital is of two types—
(i) Permanent working capital
(ii) Temporary working capital

3.1. Permanent working capital

Permanent working capital is that minimum part of the total working capital which is to be
maintained always and at every time in the business. This amount is decided by the management on
the basis of the experience.

3.2. Temporary working capital

Temporary working capital is a part of total working capital but amount of this working capital is
difficult to decide unlike permanent working capital. Actually, this type of working capital arises
because of the seasonal fluctuations in the business. For example—in the peak seasons like festive
seasons the requirement of working capital is more than the permanent requirement. This extra
requirement is called temporary working capital. It is also called—seasonal, variable, or fluctuating
working capital.
Chapter 11, Working Capital Management: 1
4. Management of working capital
The management of current assets and current liabilities is called working capital management. In
order to manage the working capital each element of it should be managed separately. If one wants
to manage the working capital then the management of the following elements is required—
1. Inventory/stock
2. Cash
3. Marketable securities
4. Receivables /debtors management
Note: Because there are certain elements of the working capital so there is a separate chapter for
each element.

5. Goal of working capital management

In the business all the elements of the working capital must be at an optimum level. We can say
that-maintaining an optimum level of working capital in the business all the time should be the goal of
the working capital management. So, the management of current assets and current liabilities is the
working capital management.

6. Trade-off between liquidity and profitability

There is an indirect relationship between liquidity and profitability of a firm. Higher the liquidity is
the lesser will be the profits and vice versa. Consider the graph given below—

Liquidity
Profitability/Liquidity

Profitability

Profitability/Liquidity

7. Trade-off between profitability and risk

There is a direct relationship between profitability and risk. Risk is defined as the possibility that a
firm will become technically insolvent. Technical Insolvency means a firm will be unable to meet its
financial obligations as and when they become due.

8. Nature of trade-off
In order to understand the nature of trade off we take some simple examples—
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 ⇒ 𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑙𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦 ⇒ 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑟𝑖𝑠𝑘
⇒ 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡𝑠
𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 ⇒ 𝐼𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑙𝑖𝑞𝑢𝑖𝑑𝑖𝑡𝑦 ⇒ 𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑟𝑖𝑠𝑘
⇒ 𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡𝑠
Let us take the following three assumptions—
(i) We are dealing with a manufacturing firm;
(ii) Current assets are less profitable than fixed assets; and
(iii) Short-term funds are less expensive than long-term funds.
Let us also assume that—
Current assets ₹5,400 Rate of return on current assets 2%
Fixed assets ₹8,600 Return on fixed assets 12%
Total assets ₹14,000
Current liabilities ₹3,200
Chapter 11, Working Capital Management: 2
8.1. Present position—
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙=₹5,400−₹3,200=₹2,200
5,400
𝑅𝑎𝑡𝑖𝑜 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = ⇒ 0.386
14,000
𝑅𝑒𝑡𝑢𝑟𝑛 ⇒ 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 = ₹5,400 × 2% = ₹0,108
𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 = ₹8,600 × 12% = ₹1,032
₹1,140

8.2. Decrease in current assets by ₹600—

𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙=(₹5,400−₹600)−₹3,200=₹1,600
5,400 − 600
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑟𝑎𝑡𝑖𝑜 = ⇒ 0.343
14,000
𝑅𝑒𝑡𝑢𝑟𝑛 ⇒ 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 = (₹5,400 − ₹600) × 2% = ₹0,096
𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 = (₹8,600 + ₹600) × 12% = ₹1,104
₹1,200

8.3. Increase in current assets by ₹600—

𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙=(₹5,400+₹600) − ₹3,200=₹2,800
5,400 + 600
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑡𝑜 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑟𝑎𝑡𝑖𝑜 = ⇒ 0.429
14,000
𝑅𝑒𝑡𝑢𝑟𝑛 ⇒ 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 = (₹5,400 + ₹600) × 2% = ₹0,120
𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 = (₹8,600 − ₹600) × 12% = ₹0,960
₹1,080

8.4. Summary
Values after Values after increase
Particulars Values at base level decrease in current in current assets by
assets by ₹600 ₹600
Working capital ₹2,200 ₹1,600 ₹2,800
Ratio of current assets
0.386 0.343 0.429
to total assets
Return on total assets ₹1,140 ₹1,200 ₹1,080
From the perusal of the summary of the above table it is clear that a decrease in the level of current
assets (i.e. decrease in liquidity) increase the return of the firm. And if there is an increase in the
liquidity then there is a decrease in the return of the firm.

9. Determining financing mix

Financing mix is the choice of sources of financing of current assets. Funds can be raised from long-
term funds or short-term funds.
There are three basic approaches
regarding financing of working Total WC
capital— Short-term Financing
Amount of working capital

9.1. Hedging/matching
approach
Hedging is the process of matching Long-term Financing

maturities of debt with the maturity

of financial needs. This approach is
also called “matching approach”,
because we try to match the maturity Time
of debt with the maturity of financial
needs.

Chapter 11, Working Capital Management: 3

Hedging approach suggests that permanent portion of working capital should be financed with
the long-term funds. Any requirement over and above the permanent requirement should be
financed with the short-term funds.
Long-term funds=Fixed assets+Total current assets
Short-term funds=Total temporary current assets

9.2. Conservative
approach Total WC
Long-term Financing
This approach suggests that the

Amount of working capital

requirement of total funds should
be met from long-term sources.
The use of short-term funds should
be restricted to only emergency Long-term Financing
situations.

Time

Long-term funds=Fixed assets+Total permanent current assets+Part of temporary current

assets
Short-term funds=Part of temporary current assets

9.3. Trade-off or balancing approach

The average requirement of working capital should be met with long-term funds. Any
requirement over and above the average requirement should be met with short-term funds.
𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 + 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑚𝑒𝑛𝑡 =
2

9.4. Aggressive Approach

Under this approach current assets are maintained just to meet the current liabilities without
keeping any cushion for the variations in working capital needs. The core working capital is
financed by long-term sources of capital and seasonal variations are met through short-term
borrowings. Adoption of this strategy will minimize the investment in net working capital and
ultimately it lowers the cost of financing the working capital. The main drawback of this strategy is
that it necessitates frequent financing the working capital and also increases the risk as the firm is
vulnerable to external shocks. A conservative current assets financing strategy would go for more
long-term finance which reduces the risk of uncertainty associated with frequent refinancing. The
price of this strategy is higher financing cost since long-term rates will normally exceed short-term
rates. But when aggressive strategy is adopted, sometimes the firm runs into mismatches and
defaults. It is the cardinal principle of corporate finance that long-term assets should be financed
with by long-term sources and short-term assets by a mix of long-term and short-term sources.
Long-term funds=Fixed assets+Part of permanent current assets
Short-term funds=Part of permanent current assets+Temporary current assets

9.5. Zero working capital approach

This is one of the latest trends in working capital management. The idea is to have zero working
capital i.e. at all times the current assets shall equal the current liabilities. Excess investment in
current assets is avoided and firm meets its current liabilities out of the matching current assets. As
current ratio is 1 and the quick ratio is below 1, there may be apprehensions about the liquidity, but
if all current assets are performing and are accounted at their realizable values, these fears are
misplaced. The firm saves opportunity cost on excess investment in current assets and as bank cash
Chapter 11, Working Capital Management: 4
credit limits are linked to the inventory levels, interest costs are also saved. There would be a self-
imposed financial discipline on the firm to manage their activities within their current liabilities and
current assets and there may not be a tendency to over borrow or divert funds. Zero working
capital also ensures a smooth and uninterrupted working capital cycle, and it would pressure the
Finance Managers to improve the quality of the current assets at all the times, to keep them 100%
realizable. There would also be a constant displacement in the current liabilities and the possibility
of having over dues may diminish. The tendency to postpone current liability payments has to be
curbed and working capital always maintained at zero. Zero working capital would call for a fine
balancing act in Financial Management, and the success in this endeavor would get reflected in
healthier bottom lines.
Total current assets=Total current liabilities; or
Total current assets−Total current liabilities=Zero

9.6. Comparative study of three approaches of financing of Net

Working Capital

Financing Requirement of Degree of risk Total cost Profit level

scheme working capital
Hedging Minimum Highest Highest Highest
Trade-off Intermediate Intermediate Intermediate Intermediate
Conservative Maximum Lowest Lowest Lowest

10. Need of working capital

There is an operating cycle in every business. There is a time gap in the phases of operating cycle.
Due to this gap the need of working capital arises. Larger the gap, larger will be the requirement of
working capital and vice versa. If there is no gap in the phases of the working capital then no
requirement of working capital arises.

Cash Raw Material

Work-in-
Progress
Operating
Cycle

Debtors/Sales Finished Goods

Note to the above diagram: Solid line represents the gap between various phases.

11. Management of working capital in India

1. Indian companies seem to have adequate level of working capital as reflected in their
liquidity ratios. Foreign companies are in a better position than Indian companies.
2. There are wide inter-industry variations in the liquidity ratios of the corporate enterprises.
Sugar industry does not have safe and satisfactory liquidity position.
3. The majority of Indian companies maintain relatively lower cash/bank balances. Marketable
securities are popular means of cash management.
4. Inventory constitutes the major part of the current assets. ABC, FNSD (Fast, Normal, Slow
and Dormant), inventory turnover ratio and comparison with competitors are widely used
to assess the performance of inventory management.
Chapter 11, Working Capital Management: 5
 5. Debtors/receivables also constitute a significant portion of current assets. “Ageing Analysis”
is used to assess the financial health of the customers before granting credit. Cash discounts
are also offered to speed up the collection. Many companies also charged penal interest.
6. The “length of the operating cycle” is the most widely used method to determine the
working capital need.
7. The working capital financing policy is based on the matching approach.
8. The majority of the companies have occasionally experienced working capital shortage
because of excess inventory accumulation and poor debt collection.

12. Determinants of working capital/Factors affecting working

capital
1. Nature of business
2. Production process
3. Production policy
a. A steady production policy
b. A variable production policy
4. Business cycle
5. Production cycle
6. Credit policy
a. Credit policy for debtors (strict or liberal)
b. Credit terms offered by suppliers
7. Accessibility to credit
8. Uncertainty in the availability of raw material
9. Growth and expansion activities
10. Level of taxes
11. Dividend policy (strict or liberal)
12. Operating efficiency
13. Price level changes (inflation)
14. Technological changes
15. Profitability
16. Sales turnover
17. Business environment factors

Chapter 11, Working Capital Management: 6

13. Estimation of operating cycle period, number of operating
cycles and estimation of working capital using operating
cycle
13.1. Operating cycle
The operating cycle can be ascertained with the help of following formula—
𝑂 =𝑅+𝑊+𝐹+𝐷−𝐶
Where,
𝑂 = Operating cycle period
𝑅 = Raw material holding period
𝑊 = Work-in-progress period
𝐹 = Finished goods holding period
𝐷 = Debtors/receivables collection period
𝐶 = Creditors payment period
Statement showing estimation of operating cycle
Particulars Days
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
× 365
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙
Raw material holding period
or 𝑥𝑥𝑥𝑥
(R) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑑𝑎𝑦
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
× 365
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠
Work-in-progress period
or 𝑥𝑥𝑥𝑥
(W) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
× 365
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Finished goods holding period
or 𝑥𝑥𝑥𝑥
(F) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 𝑝𝑒𝑟 𝑑𝑎𝑦
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
× 365
Receivables collection period or 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
𝑥𝑥𝑥𝑥
(D) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
GROSS OPERATING CYCLE 𝒙𝒙𝒙𝒙
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
× 365
Less: Creditors payment 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
period or (𝑥𝑥𝑥𝑥)
(C) 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
NET OPERATING CYCLE (CASH CYCLE) (𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶) 𝒙𝒙𝒙𝒙

13.2. Number of operating cycles in a year

365 𝑜𝑟 360 𝑑𝑎𝑦𝑠
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 =
𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑜𝑛𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

13.3. Amount of working capital requirement

𝑇𝑜𝑡𝑎𝑙 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

Chapter 11, Working Capital Management: 7

14. Estimation of working capital (Operating cycle method)
Statement showing estimation of working capital requirement
Particulars ₹
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Raw 𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑 𝑥𝑥𝑥𝑥
material ×
365𝐷/52𝑊/12𝑀
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
+𝐶𝑜𝑠𝑡 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 (ℎ𝑎𝑙𝑓)
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 ×
Work-in- +𝐶𝑜𝑠𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 (ℎ𝑎𝑙𝑓)
𝑥𝑥𝑥𝑥
progress [ (𝐸𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛) ]
𝑊𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑝𝑒𝑟𝑖𝑜𝑑
×
365𝐷/52𝑊/12𝑀
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
+𝐶𝑜𝑠𝑡 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × [ ]
Finished +𝐶𝑜𝑠𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑥𝑥𝑥𝑥
goods (𝐸𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)
𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑
×
365𝐷/52𝑊/12𝑀
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑠𝑜𝑙𝑑 𝑜𝑛 𝑐𝑟𝑒𝑑𝑖𝑡
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
+𝐶𝑜𝑠𝑡 𝑜𝑓 𝑙𝑎𝑏𝑜𝑟 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Collection +𝐶𝑜𝑠𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
×
from 𝑥𝑥𝑥𝑥
+𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆. 𝑎𝑛𝑑 𝐷𝑖𝑠𝑡. 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
debtors
[ (𝐸𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛) ]
𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑
×
365𝐷/52𝑊/12𝑀
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑎𝑟𝑡𝑖𝑐𝑢𝑙𝑎𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Prepaid 𝑇𝑖𝑚𝑒 𝑡𝑜 𝑏𝑒 𝑒𝑙𝑎𝑝𝑠𝑒𝑑 𝑏𝑒𝑓𝑜𝑟𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑥𝑥𝑥𝑥
expenses ×
365𝐷/52𝑊/12𝑀
𝐶𝑎𝑠ℎ 𝑜𝑟 𝑏𝑎𝑛𝑘 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 𝑡𝑜 𝑏𝑒 𝑚𝑎𝑖𝑛𝑡𝑎𝑖𝑛𝑒𝑑 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑢𝑠𝑖𝑛𝑒𝑠𝑠 𝑥𝑥𝑥𝑥
Total estimated current assets (A) 𝒙𝒙𝒙𝒙
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 × 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Creditors 𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑎𝑙𝑙𝑜𝑤𝑒𝑑 𝑏𝑦 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 𝑥𝑥𝑥𝑥
×
365𝐷/52𝑊/12𝑀
𝑁𝑜. 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑡𝑜 𝑏𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑
Out-
× 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑝𝑎𝑟𝑡𝑖𝑐𝑢𝑙𝑎𝑟 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 (𝐸𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)
standing 𝐿𝑎𝑔 𝑖𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑥𝑥𝑥𝑥
expenses ×
365𝐷/52𝑊/12𝑀
Total estimated current liabilities (B) 𝒙𝒙𝒙𝒙
WORKING CAPITAL (A-B) 𝒙𝒙𝒙𝒙
Add: Margin/Contingency 𝒙𝒙𝒙𝒙
REQUIRED WORKING CAPITAL 𝒙𝒙𝒙𝒙

Chapter 11, Working Capital Management: 8

15. Illustration
Important points
1. No calculation is required for taxes because these are payable out of the profits earned.
2. If in the question undrawn profit is given then it shall be ignored.
3. While estimating the investment in work-in-progress, the conversion cost shall be taken at
half value i.e. wages and overheads are to be taken at half of their values.
4. In case it is given that wages or overheads are paid at the end of the month then it means
wages or overheads are outstanding for half month.
5. Number of days in a year can be taken either 365 days or 360 days. But if days are
specifically mentioned then use those days only.
6. 1 month is equal to 4 weeks.

Example 1 (Example 1)
Calculate the operating cycle of a company which gives the following details relating to its
operations—
₹
Annual raw material consumption 8,42,000
Annual cost of production 14,25,000
Annual cost of sales 15,30,000
Annual sales 19,50,000
Average value of current assets held—
Raw materials 1,24,000
Work-in-progress 72,000
Finished goods 1,22,000
Debtors 2,60,000
The company gets 30 days credit from its suppliers. All sales made by firm are on credit basis. You
may take one year as equal to 365 days.
(ICWA Inter, 2002)

Solution
Statement showing estimation of operating cycle
Particulars Days
Raw material 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 1,24,000
holding period × 365 ⇒ × 365 54
(R) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 8,42,000
Work-in-
progress 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 72,000
× 365 ⇒ × 365 18
period 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 14,25,000
(W)
Finished goods 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 1,22,000
holding period × 365 ⇒ × 365 29
(F) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 15,30,000
Receivables 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 2,60,000
collection × 365 ⇒ × 365 49
period (D) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 19,50,000
GROSS OPERATING CYCLE 150
Less: Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
payment × 365 (𝑔𝑖𝑣𝑒𝑛) -30
period (C) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
NET OPERATING CYCLE (CASH CYCLE) 120
Hence, 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (54 + 18 + 29 + 49) − 30 = 120 𝑑𝑎𝑦𝑠

Chapter 11, Working Capital Management: 9

Example 2 (Example 2)
From the following information taken from the books of a manufacturing concern, compute the
operating cycle in days—
Period covered 365 days
Average period of credit allowed by suppliers 16 days
₹(Thousands)
Average debtors outstanding 480
Raw material consumption 4,400
Total production cost 10,000
Total cost of sales 10,500
Sales for the year 16,000
Value of the average stock maintained:
Raw materials 320
Work-in-progress 350
Finished goods 260
(B. Com. Honors, Delhi University, 1998)

Solution
Statement showing estimation of operating cycle
Particulars Days
Raw material 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 3,20,000
holding period × 365 ⇒ × 365 27
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 44,00,000
(R)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
Work-in- × 365
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠
progress 13
3,50,000
period (W) ⇒ × 365
1,00,00,000
Finished goods 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 2,60,000
holding period × 365 ⇒ × 365 9
(F) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 1,05,00,000
Receivables 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 4,80,000
collection × 365 ⇒ × 365 11
period (D) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 1,60,00,000
GROSS OPERATING CYCLE 60
Less: Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠
payment × 365 (𝑔𝑖𝑣𝑒𝑛) -16
period (C) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
NET OPERATING CYCLE (CASH CYCLE) 44
Hence, 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (27 + 13 + 9 + 11) − 16 = 44 𝑑𝑎𝑦𝑠
Note: It is assumed that total sales in on credit.

Example 3 (Illustration 2)
The relevant information for XYZ Limited for the year ended 2009 are given below—
₹
Sales 80,000
Cost of goods sold 56,000
Particulars Opening Closing
Inventory 9,000 12,000
Accounts receivables 12,000 16,000
Accounts payables 7,000 10,000
What is the length of net operating cycle? Assume 365 days in a year.
(B. Com. Honors, Delhi University, 2010)

Solution
Statement showing estimation of operating cycle
Chapter 11, Working Capital Management: 10
 Particulars Days
Inventory 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 10,500
holding period × 365 ⇒ × 365 68.44
(F) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 56,000
Accounts
receivables 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 14,000
× 365 ⇒ × 365 63.88
collection 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 80,000
period (D)
GROSS OPERATING CYCLE 132.32
Less: Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 8,500
payment × 365 ⇒ × 365 -52.58
period (C) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 59,000
NET OPERATING CYCLE (CASH CYCLE) 78.74
Hence, 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (27 + 13 + 9 + 11) − 16 = 44 𝑑𝑎𝑦𝑠
Notes:
1. It is assumed that total sales in on credit.
2. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = (𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)/2
3. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = (𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠)/2
4. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 = (𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 + 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠)/2
5. 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 = 𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 − 𝑜𝑝. 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

Example 4 (Illustration 3)
From the following data compute the duration of the operating cycle for each of the two years and
comment on the increase/decrease—
Year 1 Year 2
Particulars (₹ in thousands) (₹ in thousands)
Average stock:
Raw material 20 27
Work-in-progress 14 18
Finished goods 21 24
Purchase 96 135
Cost of goods sold 140 180
Sales 160 200
Debtors 32 50
Creditors 16 18
Assume 360 days per year for computational purposes.
(B. Com. Honors, Delhi University, 2014)

Solution
Statement showing estimation of operating cycle
Particulars Year 1 Year 2
Raw material 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 20 27
holding × 360 × 360 × 360
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 96 135
period (R) = 75 = 72
Work-in- 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 14 18
× 360 × 360
progress 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 140 180
period (W) × 360 = 36 = 36
Finished 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 21 24
goods holding × 360 × 360 × 360
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 140 180
period (F) = 54 = 48
Receivables 32 50
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 × 360 × 360
collection × 360 160 200
period (D) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 = 72 = 90
GROSS OPERATING CYCLE 237 246

Chapter 11, Working Capital Management: 11

 Less: 16 18
Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 × 360 × 360
× 360 96 135
payment 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
= 60 = 48
period (C)
NET OPERATING CYCLE (CASH CYCLE) 177 198
Hence, for year 1 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (75 + 36 + 54 + 72) − 60 = 177 𝑑𝑎𝑦𝑠
for year 2 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (72 + 36 + 48 + 90) − 48 = 198 𝑑𝑎𝑦𝑠
Comments: The operating cycle period has increased from 177 days to 198 days. So, there is an
increase of 21 days in the operating cycle period which will result in an increased requirement of
working capital.
Note: It is assumed that total sales in on credit.

Example 5
Bahar Company Limited expects its cost of goods sold for 2019-2020 to be ₹15,00,00,000. The
expected operating cycle is 60 days. Als**********o, the company wants to maintain cash balance of
₹1,00,00,000. What is the expected working capital requirement? Assume a year consisting of 360
days.

Solution

Cash cycle in days

𝐶𝑎𝑠ℎ 𝑐𝑦𝑐𝑙𝑒𝑠 𝑜𝑟 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
360 𝑑𝑎𝑦𝑠 360
= ⇒ ⇒ 6 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠
𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑜𝑛𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 60

Working capital required for the year

𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡
𝑇𝑜𝑡𝑎𝑙 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑)
= + 𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑐𝑎𝑠ℎ 𝑏𝑎𝑙𝑎𝑛𝑐𝑒
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
15,00,00,000
⇒ + 1,00,00,000 ⇒ ₹3,50,00,000
6 𝑐𝑦𝑐𝑙𝑒𝑠

Example 6 (Illustration 4)
The following information for a particular year has been extracted from the books of a
manufacturing company—
Balance sheet data
Particulars Opening (₹) Closing (₹)
Raw material 2,00,000 3,00,000
Work-in-progress 1,00,000 2,00,000
Finished goods 3,00,000 4,00,000
Debtors 3,00,000 4,00,000
Creditors 2,00,000 3,00,000
Profit and loss account data
₹
Purchases 16,00,000
Consumption of raw material 15,00,000
Total production cost 25,00,000
Total cost of goods sold 28,00,000
Total cost of sales 30,00,000
Sales 36,00,000
Assuming 360 days in a year, you are required to calculate—
1. Operating cycle in days
2. Cash cycle in days
3. Working capital required for the year
Chapter 11, Working Capital Management: 12
 (B. Com. Honors, Delhi University, 2017)

Solution

(i) Operating cycle in days

Statement showing estimation of operating cycle
Particulars Days
Raw material 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 2,50,000
holding period × 360 ⇒ × 360 60
(R) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 15,00,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
Work-in- × 360
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠
progress 21.6
1,50,000
period (W) ⇒ × 360
15,00,000
Finished goods 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 3,50,000
holding period × 360 ⇒ × 360 45
(F) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 28,00,000
Debtors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 3,50,000
collection × 360 ⇒ × 360 35
period (D) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 36,00,000
GROSS OPERATING CYCLE 161.6
Less: Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 2,50,000
payment × 360 ⇒ × 360 -56.25
period (C) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 16,00,000
NET OPERATING CYCLE (CASH CYCLE) 105.35
Hence, 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (60 + 21.6 + 45 + 35) − 56.25 = 105.35 𝑑𝑎𝑦𝑠
Note: It is assumed that total sales in on credit.

Cash cycle in days

360 𝑑𝑎𝑦𝑠
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 =
𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑜𝑛𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
360
⇒ ⇒ 3.42 𝑐𝑦𝑐𝑙𝑒𝑠
105.35

Working capital required for the year

Operating cycle method
𝑇𝑜𝑡𝑎𝑙 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
30,00,000
⇒ ⇒ ₹8,77,193
3.42 𝑐𝑦𝑐𝑙𝑒𝑠

Estimation of components of working capital method

Statement showing estimation of working capital requirement
₹
Average stock of raw material 2,50,000
Average stock of work-in-progress 1,50,000
Average stock of finished goods 3,50,000
Average debtors 3,50,000
Total current assets 11,00,000
Less: Average creditors -2,50,000
Working capital required 8,50,000

Chapter 11, Working Capital Management: 13

Example 7 (Illustration 5)
The following information is provided by DVP Limited for the year ending 31st March 2020—
Raw material storage period 50 days
Work-in-progress conversion period 18 days
Finished goods storage period 22 days
Debtors’ collection period 45 days
Creditors’ payment period 55 days
Annual operating cost ₹21 lakhs
(Including depreciation of ₹2,10,000)
(1 year=360 days)
You are required to calculate—
(i) Operating cycle period.
(ii) Number of operating cycles in a year.
(iii) Amount of working capital required for the company on a cash cost basis.
(iv) The company is a market leader in its product, there is virtually no competitor in the
market. Based on a market research, it is planning to discontinue sales on credit and deliver
products on pre-payments. Thereby, it can reduce its working capital requirement
substantially. What would be the reduction in working capital requirement due to such
decision?
(CA PCC, May, 2015)

Solution

(i) Operating cycle period

𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (50 + 18 + 22 + 45) − 55 = 80 𝑑𝑎𝑦𝑠

(ii) Number of operating cycles in a year

360 𝑑𝑎𝑦𝑠 360
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 = ⇒
𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑜𝑛𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 80
⇒ 4.5 𝑐𝑦𝑐𝑙𝑒𝑠

(iii) Amount of working capital required for the company on a cash cost
basis
𝑇𝑜𝑡𝑎𝑙 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
21,00,000 − 2,10,000 (𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)
⇒ ⇒ ₹4,20,000
4.5 𝑐𝑦𝑐𝑙𝑒𝑠

(iv) Reduction in working capital requirement

Revised operating cycle period
𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (50 + 18 + 22 + 0) − 55 = 35 𝑑𝑎𝑦𝑠

Revised number of operating cycles in a year

360 𝑑𝑎𝑦𝑠 360
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟 = ⇒
𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑜𝑛𝑒 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 35
⇒ 10.2857 𝑐𝑦𝑐𝑙𝑒𝑠

Revised amount of working capital required for the company on a cash cost
basis

Chapter 11, Working Capital Management: 14

 𝑇𝑜𝑡𝑎𝑙 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 (𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠)
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑦𝑐𝑙𝑒𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
21,00,000 − 2,10,000 (𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛)
⇒ ⇒ ₹1,83,750
10.2857 𝑐𝑦𝑐𝑙𝑒𝑠

Reduction in working capital

𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 − 𝑁𝑒𝑤 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 ⇒ ₹4,20,000 − ₹1,83,750 ⇒ ₹2,36,250

Example 8 (Same as example 6)

From the following information, calculate—
(i) The operating cycle in days. Assume 360 days in a year.
(ii) The amount of working capital required.
₹
Annual consumption of raw material 15,00,000
Total purchases 16,00,000
Total cost of production 25,00,000
Total cost of gods sold 28,00,000
Total cost of sales 30,00,000
Total sales 36,00,000
Average stock:
Raw material 2,50,000
Work-in-progress 1,50,000
Finished goods 3,50,000
Average debtors 3,50,000
Average creditors 2,50,000
(B. Com. Honors, Delhi University, 2017)

Solution

(i) Operating cycle

Statement showing estimation of operating cycle
Particulars Days
Raw material 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 2,50,000
holding period × 360 ⇒ × 360 60
(R) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑜𝑓 𝑟𝑎𝑤𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 15,00,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑤𝑜𝑟𝑘 − 𝑖𝑛 − 𝑝𝑟𝑜𝑔𝑟𝑒𝑠𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑
Work-in- × 360
𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠
progress 21.6
1,50,000
period (W) ⇒ × 360
15,00,000
Finished goods 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝑔𝑜𝑜𝑑𝑠 𝑠𝑡𝑜𝑐𝑘 ℎ𝑒𝑙𝑑 3,50,000
holding period × 360 ⇒ × 360 45
(F) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑜𝑟 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 28,00,000
Debtors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 3,50,000
collection × 360 ⇒ × 360 35
period (D) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 36,00,000
GROSS OPERATING CYCLE 161.6
Less: Creditors 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑟𝑎𝑑𝑒 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟𝑠 2,50,000
payment × 360 ⇒ × 360 -56.25
period (C) 𝐴𝑛𝑛𝑢𝑎𝑙 𝑐𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 16,00,000
NET OPERATING CYCLE (CASH CYCLE) 105.35
Hence, 𝑂 = 𝑅 + 𝑊 + 𝐹 + 𝐷 − 𝐶 ⇒ (60 + 21.6 + 45 + 35) − 56.25 = 105.35 𝑑𝑎𝑦𝑠
Note: It is assumed that total sales in on credit.

(ii) Working capital

Particulars ₹
Chapter 11, Working Capital Management: 15
 Average raw material stock 2,50,000
Average work-in-progress stock 1,50,000
Average Finished goods stock 3,50,000
Average debtors 3,50,000
Gross working capital 11,00,000
Less: Average creditors -2,50,000
Net working capital 8,50,000

Example 9 (Illustration 7)
A proforma cost sheet of a company provides you the following particulars—
Estimated cost per unit
Cost elements Amount per unit (₹)
Raw material 100
Direct labor 40
Overheads 60
Total 200
Additional information—
(i) Selling price ₹250 per unit
(ii) Level of activity 1,04,000 units of production per annum
(iii) Raw material in stock Average 4 weeks
(iv) Work-in-progress Average 2 weeks
(v) Finished goods in stock Average 4 weeks
(vi) Credit allowed by suppliers Average 4 weeks
(vii) Credit allowed to debtors Average 8 weeks
(viii) Lag in payment of wages Average 2 weeks
(ix) Cash at bank is expected to be 10% of gross working capital.

Production is carried on evenly throughout the year (52 weeks) and wages and overheads accrue
similarly. 25% of sales are on cash basis. You are required to prepare a statement of working capital
requirement.
(B. Com. Honors, Delhi University, 2015)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
4𝑊
Raw material 1,04,000 × 100 × 8,00,000
52𝑊
40 60 2𝑊
Work-in-progress 1,04,000 × (100 + + )× 6,00,000
2 2 52𝑊
4𝑊
Finished goods 1,04,000 × (100 + 40 + 60) × 16,00,000
52𝑊
75 8𝑊
Debtors 1,04,000 × (100 + 40 + 60) × × 24,00,000
100 52𝑊
Cash or bank balance to be maintained in the business
6,00,000
(See note)
Gross working capital/Total current assets (A) 60,00,000
4𝑊
Creditors 1,04,000 × 100 × 8,00,000
52𝑊
2𝑊
Wages 1,04,000 × 40 × 1,60,000
52𝑊
Total current liabilities (B) 9,60,000
WORKING CAPITAL (A-B) 50,40,000
Add: Margin/Contingency --

Chapter 11, Working Capital Management: 16

 REQUIRED WORKING CAPITAL 50,40,000
Note:
Cash at bank is expected to be 10% of the gross working capital and gross working means total
current assets. Current assets include bank balance also. Excluding bank balance, the total current
assets are ₹54,00,000 (𝑖. 𝑒. 8𝐿 + 6𝐿 + 16𝐿 + 24𝐿). If total current assets are 100% and bank balance
is 10% then remaining current assets are 90%. So, the bank balance would be—
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑏𝑎𝑛𝑘 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 54,00,000
× 100 ⇒ × 10 ⇒ ₹60,00,000
90% 90

So, the total current assets are ₹60,00,000 𝑖. 𝑒. ₹54,00,000 + ₹6,00,000.

You can also check that the bank balance of ₹6,00,000 𝑖𝑠 10% 𝑜𝑓 𝑡ℎ𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠.

Example 10 (Illustration 8)
Estimate the working capital requirement from the following particulars—
Production for the year 69,000 units
Finished goods in store 3 months
Raw material in store 2 months
Production process 1 month
Credit allowed by suppliers 2 months
Credit allowed to debtors 3 months
Selling price per unit ₹50
Raw material cost 50% of selling price
Direct wages 10% of selling price
Manufacturing overheads 16% of selling price
Selling overheads 4% of selling price
There is a regular production and sales cycle and wages and overheads accrue uniformly. Wages are
paid with a lag of one month. Assume that full material is issued to the production in the beginning
of the production process.
(B. Com. Honors, Delhi University, 2007 and slightly modified in 2010; BBS Honors, Delhi University,
2014)

Solution
Let us calculate various components of the cost—
𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 50% ⇒ ₹50 × 50% ₹25
𝑊𝑎𝑔𝑒𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 10% ⇒ ₹50 × 10% ₹5
𝑀𝑎𝑛𝑢𝑓. 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 16% ⇒ ₹50 × 16% ₹8
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 4% ⇒ ₹50 × 4% ₹2
Total cost ₹40
Profit ₹10
Selling price ₹50
Statement showing estimation of working capital requirement
Particulars ₹
2𝑀
Raw material 69,000 × 25 × 2,87,500
12𝑀
5 8 1𝑀
Work-in-progress 69,000 × (25 + + ) × 1,81,125
2 2 12𝑀
3𝑀
Finished goods 69,000 × (25 + 5 + 8) × 6,55,500
12𝑀
3𝑀
Debtors 69,000 × (25 + 5 + 8 + 2) × 6,90,000
12𝑀
Cash or bank balance to be maintained in the business --

Gross working capital/Total current assets (A) 18,14,125

Chapter 11, Working Capital Management: 17

 2𝑀
Creditors 69,000 × 25 × 2,87,500
12𝑀
1𝑀
Wages 69,000 × 5 × 28,750
12𝑀
Total current liabilities (B) 3,16,250
WORKING CAPITAL (A-B) 14,97,875
Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 14,97,875

Example 11 (Illustration 9)
From the following information prepare an estimate of working capital requirements—
(i) Projected annual sales 52,000 units
(ii) Selling price ₹60 per unit
(iii) Raw material cost 40% of selling price
(iv) Direct labor cost 30% of selling price
(v) Overheads 20% of selling price
Raw materials remain in stock on an average for 3 weeks. Goods remain in production process for 4
weeks on an average. 5 weeks are allowed to debtors to pay while firm gets 3 weeks credit from
suppliers.
Finished goods remain in stock for one month. Lag in payment of wages and overheads expenses is
two weeks. 50% sales are on cash basis. Assume that goods in process are 100% complete with
respect to materials but only 50% in conversion costs.
(B. Com. Honors, Delhi University, 2006, 2017)

Solution
1. In this question weeks and months both are given. In case weeks are given then divide by 52
weeks and multiply by weeks and in case months are given then divide by months and
multiply by months.
2. Conversion cost is (𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑐𝑜𝑠𝑡 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑟𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙) or (𝐷𝑖𝑟𝑒𝑐𝑡 𝑤𝑔𝑎𝑒𝑠 +
𝐷𝑖𝑟𝑒𝑐𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 + 𝐹𝑎𝑐𝑡𝑜𝑟𝑦/𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑟𝑢𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠).
3. Various components of cost are—
𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 40% ⇒ 𝑅𝑠. 60 × 40% ₹24
𝑊𝑎𝑔𝑒𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 30% ⇒ 𝑅𝑠. 60 × 30% ₹18
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 20% ⇒ 𝑅𝑠. 60 × 20% ₹12
Total ₹54
Profit ₹6
Selling price ₹50
Statement showing estimation of working capital requirement
Particulars ₹
3𝑊
Raw material 52,000 × 24 × 72,000
52𝑊
18 12 4𝑊
Work-in-progress 52,000 × (24 + + )× 1,56,000
2 2 52𝑊
1𝑀
Finished goods 52,000 × (24 + 18 + 12) × 2,34,000
12𝑀
5𝑊
Debtors 52,000 × (24 + 18 + 12) × 50% × 1,35,000
52𝑊
Cash or bank balance to be maintained in the business --

Gross working capital/Total current assets (A) 5,97,000

3𝑊
Creditors 52,000 × 24 × 72,000
52𝑊
Chapter 11, Working Capital Management: 18
 2𝑊
Wages 52,000 × 18 × 36,000
52𝑊
2𝑊
Overheads 52,000 × 12 × 24,000
52𝑊
Total current liabilities (B) 1,32,000
WORKING CAPITAL (A-B) 4,65,000
Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 4,65,000

Example 12 (Illustration 11)

Calculate the working capital requirement of a company based on the information provided
below—
Estimated cost per unit of production Amount per unit (₹)
Raw materials 80
Direct labor 30
Overhead (inclusive of depreciation of ₹10 per unit) 70
Total cost 180
Additional information—
Selling price, ₹200 per unit; Level of activity 1,04,000 units of production per annum
Raw material in stock, average 4 weeks
Work-in-progress (Assume 50 percent completion stage in respect of labor and overheads costs and
100 percent completion in respect of materials), average 2 weeks
Finished goods in stock, average 4 weeks
Credit allowed by suppliers: Average 4 weeks; Credit allowed to debtors: Average 8 weeks
Lag in payment of wages: Average 1.5 weeks; Cash at bank is expected to be ₹20,000
You may assume that production is carried on evenly throughout the year (52 weeks) and wages
and overheads accrue similarly. All sales are on credit basis only.
(BBS Honors, Delhi University, 2013)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
4𝑊
Raw material 1,04,000 × 80 × 6,40,000
52𝑊
30 (70 − 10) 2𝑊
Work-in-progress 1,04,000 × (80 + + )× 5,00,000
2 2 52𝑊
4𝑊
Finished goods 1,04,000 × (80 + 30 + (70 − 10)) × 13,60,000
52𝑊
8𝑊
Debtors 1,04,000 × (80 + 30 + (70 − 10)) × 27,20,000
52𝑊
Cash or bank balance to be maintained in the business 20,000

Gross working capital/Total current assets (A) 52,40,000

4𝑊
Creditors 1,04,000 × 80 × 6,40,000
52𝑊
1.5𝑊
Wages 1,04,000 × 30 × 90,000
52𝑊
Total current liabilities (B) 7,30,000

WORKING CAPITAL (A-B) 45,10,000

Chapter 11, Working Capital Management: 19
 Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 45,10,000

Example 13 (Illustration 12)

The cost sheet of PQR Limited provides the following data—
Cost per unit Amount per unit (₹)
Raw materials 50
Direct labor 20
Overheads (inclusive of depreciation of ₹10 per unit) 40
Total cost 110
Profit 20
Selling price 130
Average raw material in stock is for one month. Average material in work-in-progress is for half
month. Credit allowed by suppliers: One month; Credit allowed to debtors: One month. Average
time lag in payment of wages is 10 days. Average time lag in payment of overheads is 30 days. 25%
of sales are on cash basis. Cash at bank is expected to be ₹1,00,000. Finished goods lie in warehouse
for one month. You are required to prepare a statement showing working capital needed to finance
a level of activity of 54,000 units of output. Production is carried out evenly throughout the year and
wages and overheads accrue similarly. State your assumptions, if any, clearly.
(B. Com. Honors, Delhi University, 2016, similar question in 2013)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
1𝑀
Raw material 54,000 × 50 × 2,25,000
12𝑀
20 (40 − 10) 0.5𝑀
Work-in-progress 54,000 × (50 + + )× 1,68,750
2 2 12𝑀
1𝑀
Finished goods 54,000 × (50 + 20 + (40 − 10)) × 4,50,000
12𝑀
1𝑀
Debtors 54,000 × (50 + 20 + (40 − 10)) × 50% × 3,37,500
12𝑀
Cash or bank balance to be maintained in the business 1,00,000

Gross working capital/Total current assets (A) 12,81,250

1𝑀
Creditors 54,000 × 50 × 2,25,000
12𝑀
10𝐷
Labor 54,000 × 20 × 30,000
360𝐷
30𝐷
Overheads 54,000 × 30 × 1,35,000
360𝐷
Total current liabilities (B) 3,90,000
WORKING CAPITAL (A-B) 8,91,250
Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 8,91,250
Assumptions:
1. Number of days in year are assumed to be 360.
2. Deprecation being a non-cash expenses has been excluded while estimating the working
capital.
3. Degree of completion of work-in-progress is assume to be 100% in respect of material and
50% in respect of labor and overheads.

Chapter 11, Working Capital Management: 20

Example 14 (Example 4)
Following information is extracted from last year’s annual accounts of XYZ Limited—
₹
Sales at 3 months credit 40,00,000
Raw material consumed 12,00,000
Wages paid (15 days in arrears) 9,60,000
Manufacturing expenses (1 month in arrears) 13,00,000
Administrative expenses (1 month in arrears) 4,80,000
Sales promotion expenses (Paid half yearly in advance) 2,00,000
The company enjoys one month’s credit from the suppliers of raw materials and maintains two
months’ stock of raw materials and one and half months’ finished goods. Manufacturing expenses
include depreciation of ₹1,00,000. Cash balance of ₹1,00,000 is maintained as a precautionary
measure. Due to increased scale of operations management is expecting an increase of 20% in
working capital requirement for the current year. Find out net working capital needed for the
current year’s operations.

Solution
Statement showing estimation of working capital requirement
Particulars ₹
2𝑀
Raw material 12,00,000 × 2,00,000
12𝑀
1.5𝑀
Finished goods 33,60,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 1) 4,20,000
12𝑀
3𝑀
Debtors 40,40,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 10,10,000
12𝑀
Sales promotion 6𝑀
2,00,000 × 1,00,000
expenses 12𝑀

Cash or bank balance to be maintained in the business 1,00,000

Gross working capital/Total current assets (A) 18,30,000

1𝑀
Creditors 12,00,000 × 1,00,000
12𝑀
0.5𝑀
Wages 9,60,000 × 40,000
12𝑀
Manufacturing 1𝑀
(13,00,000 − 1,00,000 (𝐷𝑒𝑝. )) × 1,00,000
expenses 12𝑀
Administrative 1𝑀
4,80,000 × 40,000
expenses 12𝑀

Total current liabilities (B) 2,80,000

WORKING CAPITAL (A-B) 15,50,000
Add: Increase in working capital @ 20% 3,10,000
REQUIRED WORKING CAPITAL 18,60,000
Notes:
1. Cost of production for finished goods
Raw materials 12,00,000
Wages 9,60,000
Manufacturing expenses (₹13,00,0000-₹1,00,000 (Dep.)) 12,00,000
Cost of production 33,60,000
2. Cost of sales for debtors
Cost of production 33,60,000
Chapter 11, Working Capital Management: 21
 Add: Administration expenses 4,80,000
Add: Sales promotion expenses 2,00,000
Cost of sales 40,40,000
3. Depreciation being a non-cash expense has been excluded while estimating working capital.

Example 15
Following information is extracted from last year’s annual accounts of XYZ Limited—
₹
Sales at 3 months credit 40,00,000
Raw material consumed 12,00,000
Wages paid (15 days in arrears) 9,60,000
Manufacturing expenses (1 month in arrears) 13,00,000
Administrative expenses (1 month in arrears) 4,80,000
Sales promotion expenses (Paid half yearly in advance) 2,00,000
The company enjoys one month’s credit from the suppliers of raw materials and maintains two
months’ stock of raw materials and one and half months’ finished goods. Manufacturing expenses
include depreciation of ₹1,00,000. Cash balance of ₹1,00,000 is maintained as a precautionary
measure. Due to increased scale of operations management is expecting an increase of 20% in
working capital requirement for the current year.
Also, the XYZ Limited have approached their bankers for their working capital requirement, who
have agreed to sanction the same by retaining the margins as under—
Raw material 20%
Finished goods 30%
Debtors 10%
Find out net working capital needed for the current year’s operations and the working capital limits
likely to be approved by bankers.

Solution
Statement showing estimation of working capital requirement
Particulars ₹
2𝑀
Raw material 12,00,000 × 2,00,000
12𝑀
1.5𝑀
Finished goods 33,60,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 1) 4,20,000
12𝑀
3𝑀
Debtors 40,40,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 10,10,000
12𝑀
Sales promotion 6𝑀
2,00,000 × 1,00,000
expenses 12𝑀

Cash or bank balance to be maintained in the business 1,00,000

Gross working capital/Total current assets (A) 18,30,000

1𝑀
Creditors 12,00,000 × 1,00,000
12𝑀
0.5𝑀
Wages 9,60,000 × 40,000
12𝑀
Manufacturing 1𝑀
12,00,000 × 1,00,000
expenses 12𝑀
Administrative 1𝑀
4,80,000 × 40,000
expenses 12𝑀

Total current liabilities (B) 2,80,000

Chapter 11, Working Capital Management: 22

 WORKING CAPITAL (A-B) 15,50,000
Add: Increase in working capital @ 20% 3,10,000
REQUIRED WORKING CAPITAL 18,60,000

Working capital limits likely to be approved by bankers

Working capital Credit limit likely to be
needed by company Margin to be retained sanctioned by banker
Particulars (₹) by banker (₹)
80
Raw material 2,00,000 20% 2,00,000 × = 1,60,000
100
Finished 70
4,20,000 30% 4,20,000 × = 2,94,000
goods 100
90
Debtors 10,10,000 10% 10,10,000 ×
100
= 9,09,000
Total working capital limit to be approved by bankers 13,63,000
Notes:
1. Cost of production for finished goods
Raw materials 12,00,000
Wages 9,60,000
Manufacturing expenses 12,00,000
Cost of production 33,60,000
2. Cost of sales for debtors
Cost of production 33,60,000
Add: Administration expenses 4,80,000
Add: Sales promotion expenses 2,00,000
Cost of sales 40,40,000
3. Depreciation being a non-cash expense has been excluded while estimating working capital.

Example 16
Raju Brothers Private Limited sells goods at a gross profit of 25%. Depreciation is taken into
account as a part of the cost of production. The following are the annual figures given to you—
₹
Sales (two months’ credit) 18,00,000
Material consumed (one month credit) 4,50,000
Wages (one month lag in payment) 3,60,000
Cash manufacturing expenses (one month lag in payment) 4,80,000
Administrative expenses (one month lag in payment) 1,20,000
Sales promotion expenses (paid quarterly in advance) 60,000
Income tax payable in 4 installments of which one lies in next year 1,50,000
The company keeps one month’s stock each of raw material and finished goods. It also keeps
₹1,00,000 in cash. You are required to estimate the working capital requirements of the company
on cash cost basis assuming 15% safety margin. Ignore work-in-progress.

Solution
Statement showing estimation of working capital requirement
Particulars ₹
1𝑀
Raw material 4,50,000 × 37,500
12𝑀
1𝑀
Finished goods 12,90,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 1,07,500
12𝑀
2𝑀
Debtors 14,70,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 3) 2,45,000
12𝑀

Chapter 11, Working Capital Management: 23

 Sales promotion 3𝑀
60,000 × 15,000
expenses 12𝑀

Cash or bank balance to be maintained in the business 1,00,000

Gross working capital/Total current assets (A) 5,05,000

Creditors 37,500

1𝑀
Wages 3,60,000 × 30,000
12𝑀
Cash manufacturing 1𝑀
4,80,000 × 40,000
expenses 12𝑀
Administrative 1𝑀
1,20,000 × 10,000
expenses 12𝑀

Total current liabilities (B) 1,17,500

WORKING CAPITAL (A-B) 3,87,500

Add: Margin/Contingency @ 15% 58,125
REQUIRED WORKING CAPITAL 4,45,625
Notes:
1. Depreciation
Sales 18,00,000
Less: Gross profit @ 25% -4,50,000
Total manufacturing cost 13,50,000
Less: Material consumed -4,50,000
Less: Wages -3,60,000
Total manufacturing expenses 5,40,000
Less: Cash manufacturing expenses -4,80,000
Depreciation 60,000
2. Cash manufacturing cost
Total manufacturing cost 13,50,000
Less: Depreciation (non-cash expense) (𝑠𝑒𝑒 𝑛𝑜𝑡𝑒 1) -60,000
Cash cost of manufacturing 12,90,000
3. Cash cost of sales
Cash cost of manufacturing 12,90,000
Add: Administrative expenses 1,20,000
Add: Sales promotion expenses 60,000
Cash cost of sales 14,70,000
4. Income tax has been ignored as it is paid out of the profits earned.

Example 17 (Same as Example 16)

Following figures relate to Shah Brothers Private Limited—
₹
Sales (two months’ credit) 3,60,000
Material consumed (two month credit) 90,000
Wages (one month in arrear) 72,000
Manufacturing expenses outstanding at the end of the year 8,000
(Expenses are paid one month in arrear)
Administrative expenses (one month in arrear) 24,000
Sales promotion expenses (paid quarterly in advance) 12,000
The company sells its products on gross profit of 25% considering depreciation as cost of
production. The company keeps one month’s stock each of raw material and finished goods. It also

Chapter 11, Working Capital Management: 24

keeps ₹10,000 in cash. You are required to estimate the working capital requirements of the
company on cash cost basis assuming 20% safety margin. Ignore work-in-progress.

Solution
Statement showing estimation of working capital requirement
Particulars ₹
1𝑀
Raw material 90,000 × 7,500
12𝑀
1𝑀
Finished goods 2,58,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 21,500
12𝑀
2𝑀
Debtors 2,94,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 3) 49,000
12𝑀
Sales promotion 3𝑀
12,000 × 3,000
expenses 12𝑀

Cash or bank balance to be maintained in the business 10,000

Gross working capital/Total current assets (A) 91,000

2𝑀
Creditors 90,000 × 15,000
12𝑀
1𝑀
Wages 72,000 × 6,000
12𝑀
Cash manufacturing
Given 8,000
expenses
Administrative 1𝑀
24,000 × 2,000
expenses 12𝑀

Total current liabilities (B) 31,000

WORKING CAPITAL (A-B) 60,000
Add: Margin/Contingency @ 20% 12,000
REQUIRED WORKING CAPITAL 72,000
Notes:
1. Depreciation
Sales 3,60,000
Less: Gross profit @ 25% -90,000
Total manufacturing cost 2,70,000
Less: Material consumed -90,000
Less: Wages -72,000
Total manufacturing expenses 1,08,000
Less: Cash manufacturing expenses (𝑅𝑠. 8,000 × 12) -96,000
Depreciation 12,000
2. Cash manufacturing cost
Total manufacturing cost 2,70,000
Less: Depreciation (non-cash expense) -12,000
Cash cost of manufacturing 2,58,000
3. Cash cost of sales
Cash cost of manufacturing 2,58,000
Add: Administrative expenses 24,000
Add: Sales promotion expenses 12,000
Cash cost of sales 2,94,000

Chapter 11, Working Capital Management: 25

Example 18 (Illustration 5) (Same as Example 16)
The following figures relate to ABC Limited—
₹
Sales at three months’ credit 90,00,000
Material consumed 22,50,000
(Suppliers extend one and half month’s credit)
Wages 18,00,000
(One month in arrear)
Manufacturing expenses outstanding at the end of the year 2,00,000
(Cash expenses are paid one month in arrear)
Total administrative expenses for the year 6,00,000
(Cash expenses are paid one month in arrear)
Sales promotion expenses 12,00,000
(Paid quarterly in advance)
The company sells its product on gross profit of 25% assuming depreciation as a part of cost of
production.
It keeps two months’ stock of finished goods and one month’s stock of raw material. It keeps cash
balance of ₹2,50,000.
Assume a 5% safety margin, work out the working capital requirement of the company on cash cost
basis. Ignore work-in-progress.
(CA PEE, 2004)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
1𝑀
Raw material 22,50,000 × 1,87,500
12𝑀
2𝑀
Finished goods 64,50,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 10,75,000
12𝑀
3𝑀
Debtors 82,50,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 3) 20,62,500
12𝑀
Sales promotion 3𝑀
12,00,000 × 3,00,000
expenses 12𝑀

Cash or bank balance to be maintained in the business 2,50,000

Gross working capital/Total current assets (A) 38,75,000

1.5𝑀
Creditors 22,50,000 × 2,81,250
12𝑀
1𝑀
Wages 18,00,000 × 1,50,000
12𝑀
Manufacturing 1𝑀
24,00,000 × 2,00,000
expenses 12𝑀
Administrative 1𝑀
6,00,000 × 50,000
expenses 12𝑀

Total current liabilities (B) 6,81,250

WORKING CAPITAL (A-B) 31,93,750
Add: Safety margin @ 5% 1,59,688
REQUIRED WORKING CAPITAL 33,53,438
Notes:
1. Depreciation
Chapter 11, Working Capital Management: 26
 Sales 90,00,000
Less: Gross profit @ 25% -22,50,000
Total manufacturing cost 67,50,000
Less: Material consumed -22,50,000
Less: Wages -18,00,000
Total manufacturing expenses 27,00,000
Less: Cash manufacturing expenses (₹2,00,000 × 12) -24,00,000
Depreciation 3,00,000
2. Cash manufacturing cost
Total manufacturing cost 67,50,000
Less: Depreciation (non-cash expense) -3,00,000
Cash cost of manufacturing 64,50,000
3. Cash cost of sales
Cash cost of manufacturing 64,50,000
Add: Administrative expenses 6,00,000
Add: Sales promotion expenses 12,00,000
Cash cost of sales 82,50,000

Example 19 (Illustration13) (Same as Example 16)

X Limited sells goods at gross profit of 20%. It includes depreciation as a part of cost of
production. The following figures for the 12 months period ending March 31st of the current year
are given. Ascertain the requirement of working capital of the company on a cash cost basis.
In your working, you are required to assume—
(i) A safety margin of 15% will be maintained.
(ii) Cash is to be held to the extent of 50% of current liabilities.
(iii) There will be no work-in-progress.
(iv) Tax is to be ignored.
(v) Finished goods are to be valued at manufacturing costs. Stocks of raw material and finished
goods are kept at one month’s requirement. Further,
a. Sales at 2 month’s credit, ₹27,00,000.
b. Material consumed (Supplier’s credit is for 2 months), ₹6,75,000.
c. Wages (Paid on the last day of the month), ₹5,40,000.
d. Manufacturing expenses outstanding at the end of the year (Cash expenses are paid one
month in arrear), ₹60,000.
e. Total administrative expenses (Paid as above), ₹1,80,000.
f. Sales promotion expenses (Paid quarterly in advance), ₹90,000.
(BBS Honors, Delhi University, 2011)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
1𝑀
Raw material 6,75,000 × 56,250
12𝑀
1𝑀
Finished goods 19,35,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 1,61,250
12𝑀
2𝑀
Debtors 22,05,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 3) 3,67,500
12𝑀
Sales promotion 3𝑀
90,000 × 22,500
expenses 12𝑀
Cash or bank balance to be maintained in the business
1,05,000
(𝑠𝑒𝑒 𝑛𝑜𝑡𝑒 4)

Gross working capital/Total current assets (A) 7,12,500

Chapter 11, Working Capital Management: 27

 2𝑀
Creditors 6,75,000 × 1,12,500
12𝑀
0.5𝑀
Wages 5,40,000 × 22,500
12𝑀
Manufacturing 1𝑀
7,20,000 × 60,000
expenses 12𝑀
Administrative 1𝑀
1,80,000 × 15,000
expenses 12𝑀

Total current liabilities (B) 2,10,000

WORKING CAPITAL (A-B) 5,02,500
Add: Safety margin @ 15% 73,375
REQUIRED WORKING CAPITAL 5,75,875
Notes:
1. Depreciation
Sales 27,00,000
Less: Gross profit @ 20% -5,40,000
Total manufacturing cost 21,60,000
Less: Material consumed -6,75,000
Less: Wages -5,40,000
Total manufacturing expenses 9,45,000
Less: Cash manufacturing expenses (𝑅𝑠. 60,000 × 12) -7,20,000
Depreciation 2,25,000
2. Cash manufacturing cost
Total manufacturing cost 21,60,000
Less: Depreciation (non-cash expense) -2,25,000
Cash cost of manufacturing 19,35,000
3. Cash cost of sales
Cash cost of manufacturing 19,35,000
Add: Administrative expenses 1,80,000
Add: Sales promotion expenses 90,000
Cash cost of sales 22,05,000
4. Cash balance: 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 × 50% ⇒ ₹2,10,000 × 50% ⇒ ₹1,05,000

Example 20 (Same as Example 16)

From the following information estimated by Swastik Limited for the next year, calculate the
working capital required on cash cost basis—
₹
Sales (at gross profit of 20%) 27,00,000
Raw material 6,75,000
Wages 5,40,000
Manufacturing expenses outstanding at the end of the year 60,000
Total administrative expenses ₹1,80,000
Total selling expenses 90,000
Desired cash balance ₹1,00,000
Finished goods and raw material are kept in stock to meet 1 month’s requirement. The company
gives a credit of 2 months to its customers and gets a credit of 2 months from its suppliers. Wages
are paid with a time lag of 15 days. All other expenses are paid with a time lag of 1 month. There is
no work-in-progress. The company includes depreciation in its cost of production. Finished goods
are valued at manufacturing cost. A safety margin of 15% is to be maintained.
(B. Com. Honors, Delhi University, 2019)

Solution
Statement showing estimation of working capital requirement
Chapter 11, Working Capital Management: 28
 Particulars ₹
1𝑀
Raw material 6,75,000 × 56,250
12𝑀
1𝑀
Finished goods 19,35,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 2) 1,61,250
12𝑀
2𝑀
Debtors 22,05,000 × (𝑆𝑒𝑒 𝑛𝑜𝑡𝑒 3) 3,67,500
12𝑀

Cash or bank balance to be maintained in the business 1,00,000

Gross working capital/Total current assets (A) 6,85,000

2𝑀
Creditors 6,75,000 × 1,12,500
12𝑀
0.5𝑀
Wages 5,40,000 × 22,500
12𝑀
Manufacturing 1𝑀
7,20,000 × 60,000
expenses 12𝑀
1𝑀
Selling expenses 90,000 × 7,500
12𝑀
Administrative 1𝑀
1,80,000 × 15,000
expenses 12𝑀
Total current liabilities (B) 2,17,500

WORKING CAPITAL (A-B) 4,67,500

Add: Safety margin @ 15% 70,125
REQUIRED WORKING CAPITAL 5,37,625
Notes:
1. Depreciation
Sales 27,00,000
Less: Gross profit @ 20% -5,40,000
Total manufacturing cost 21,60,000
Less: Material consumed -6,75,000
Less: Wages -5,40,000
Total manufacturing expenses 9,45,000
Less: Cash manufacturing expenses (𝑅𝑠. 60,000 × 12) -7,20,000
Depreciation 2,25,000
2. Cash manufacturing cost
Total manufacturing cost 21,60,000
Less: Depreciation (non-cash expense) -2,25,000
Cash cost of manufacturing 19,35,000
3. Cash cost of sales
Cash cost of manufacturing 19,35,000
Add: Administrative expenses 1,80,000
Add: Selling expenses 90,000
Cash cost of sales 22,05,000

Example 21
Estimated current assets ₹25,000; estimated current liabilities ₹8,000; Contingency/margin
safety is 15% of total working capital. Calculate total working capital requirement.

Solution
₹
Chapter 11, Working Capital Management: 29
 Estimated current assets 25,000
Less: Estimated current liabilities -8,000
Net working capital 17,000
Add: Contingency/safety margin (See note) 3,000
Total working capital requirement 20,000
Note:
𝑁𝑒𝑡 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙
𝐶𝑜𝑛𝑡𝑖𝑛𝑔𝑒𝑛𝑐𝑦 𝑜𝑟 𝑠𝑎𝑓𝑒𝑡𝑦 𝑚𝑎𝑟𝑔𝑖𝑛 = × % 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑚𝑎𝑟𝑔𝑖𝑛
100 − 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑠𝑎𝑓𝑒𝑡𝑦 𝑚𝑎𝑟𝑔𝑖𝑛
17,000
⇒ × 15 ⇒ ₹3,000
100 − 15
Verification: 𝑆𝑎𝑓𝑒𝑡𝑦 𝑚𝑎𝑟𝑔𝑖𝑛 = 𝑇𝑜𝑡𝑎𝑙 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 × 15% ⇒ ₹20,000 × 15% ⇒ ₹3,000

Example 22
The following information is extracted from last year’s annual accounts of ABC Limited—
Details Amount per unit (₹)
Raw material cost 100.00
Direct labor cost 37.50
Overhead cost 75.00
Total cost 212.50
Profit 37.50
Selling price 250.00
The company keeps raw material in stock on an average for four weeks, work-in-progress in stock
on an average for one week and finished goods in stock on an average for two weeks. The credit
period allowed by suppliers is three weeks and company allows four weeks credit to its debtors.
The lag in payment of wages is one week and lag in payment of overhead expenses is two weeks.
The company sells one-fifth of its output against the cash and maintains cash in hand and at bank
balance put together at ₹37,500.
You are required to prepare an estimate of working capital needed to finance an activity level of
1,30,000 units of production. Assume that production is carried on evenly throughout the year and
overheads and wages accrue similarly. Work-in-progress stock is 80% complete in all respects.
(B. Com. Honors, Delhi University, 2018)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
4𝑊
Raw material 1,30,000 × 100 × 10,00,000
52𝑊
80 1𝑊
Work-in-progress 1,30,000 × (100 + 37.50 + 75) × × 4,25,000
100 52𝑊
2𝑊
Finished goods 1,30,000 × (100 + 37.50 + 75) × 10,62,500
52𝑊
4 4𝑊
Debtors 1,30,000 × (100 + 37.50 + 75) × × 17,00,000
5 52𝑊
Cash or bank balance to be maintained in the business 37,500

Gross working capital/Total current assets (A) 42,25,000

3𝑊
Creditors 1,30,000 × 100 × 7,50,000
52𝑊
1𝑊
Wages 1,30,000 × 37.50 × 93,750
52𝑊
2𝑊
Overheads 1,30,000 × 75 × 3,75,000
52𝑊
Total current liabilities (B) 12,18,750

Chapter 11, Working Capital Management: 30

 WORKING CAPITAL (A-B) 30,06,250
Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 30,06,250

Example 23
A company provides you the following facts. Estimate the net working capital required for the
project—
Estimated cost per unit of production
Amount per unit (₹)
Raw material 80
Direct labor 30
Overheads (Including depreciation of ₹10 per unit) 70
Total 180
Additional information—
(i) Selling price: ₹200 per unit
(ii) Level of activity: 1,56,000 units of production per annum
(iii) Raw material in stock: Average 4 weeks
(iv) Work-in-progress (Assume 50% completion state in respect of conversion cost and
100% completion in respect of material): Average 2 weeks
(v) Finished goods in stock: Average 4 weeks
(vi) Credit allowed by suppliers: Average 4 weeks
(vii) Credit allowed to debtors: Average 8 weeks
(viii) Lag in payment of wages: Average 1.5 weeks
(ix) Cash at bank is expected to be: ₹25,000
You may assume that production is carried on evenly during the year. All sales are on credit basis.
Add 10% to your computed figure to allow for contingencies.
(B. Com. Honors, Delhi University, 2011)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
4𝑊
Raw material 1,56,000 × 80 × 9,60,000
52𝑊
30 (70 − 10) 2𝑊
Work-in-progress 1,56,000 × (80 + + )× 7,50,000
2 2 52𝑊
4𝑊
Finished goods 1,56,000 × (80 + 30 + (70 − 10)) × 20,40,000
52𝑊
8𝑊
Debtors 1,56,000 × (80 + 30 + (70 − 10)) × 40,80,000
52𝑊
Cash or bank balance to be maintained in the business 25,000

Gross working capital/Total current assets (A) 78,55,000

4𝑊
Creditors 1,56,000 × 80 × 9,60,000
52𝑊
1.5𝑊
Wages 1,56,000 × 30 × 1,35,000
52𝑊
Total current liabilities (B) 10,95,000
WORKING CAPITAL (A-B) 67,60,000
Add: Margin/Contingency @ 10% 6,76,000
REQUIRED WORKING CAPITAL 74,36,000

Chapter 11, Working Capital Management: 31

Example 24
X Limited plans to sell 1,20,000 units next year. The expected cost of goods sold is as follows—
Raw material ₹100
Wages ₹30
Overheads (Including depreciation of ₹5 per unit) ₹25
Selling price ₹200
The duration of various stages of operating cycle is expected to be as follows—
Raw material stage 2 months
Work-in-progress stage 1 month
Finished goods stage ½ month
Debtors stage 1 month
Estimate the working capital requirement if the desired cash balance is 5% of gross working
capital requirement.
(B. Com. Honors, Delhi University, 2013)

Solution
Statement showing estimation of working capital requirement
Particulars ₹
2𝑀
Raw material 1,20,000 × 100 × 20,00,000
12𝑀
30 (25 − 5) 1𝑀
Work-in-progress 1,20,000 × (100 + + )× 12,50,000
2 2 12𝑀
0.5𝑀
Finished goods 1,20,000 × (100 + 30 + (25 − 5)) × 7,50,000
12𝑀
1𝑀
Debtors 1,20,000 × (100 + 30 + (25 − 5)) × 15,00,000
12𝑀
Cash or bank balance to be maintained in the business
2,89,474
(𝑠𝑒𝑒 𝑛𝑜𝑡𝑒)
Gross working capital/Total current assets 57,89,474
Note:
Cash at bank is expected to be 5% of the gross working capital and gross working means total
current assets. Current assets include bank balance also. Excluding bank balance, the total current
assets are ₹55,00,000 (𝑖. 𝑒. 20𝐿 + 12.50𝐿 + 7.50𝐿 + 15𝐿). If total current assets are 100% and bank
balance is 5% then remaining current assets are 95%. So, the bank balance would be—
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑏𝑎𝑛𝑎𝑘 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 55,00,000
× 100 ⇒ × 5 ⇒ ₹2,89,474
100% − 5% = 95% 95

So, the total current assets are ₹60,00,000 𝑖. 𝑒. ₹54,00,000 + ₹6,00,000.

You can also see that the bank balance of ₹6,00,000 𝑖𝑠 10% 𝑜𝑓 𝑡ℎ𝑒 𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠.

Example 25
XYZ Limited supplied the following information—
Sales and production for the year 69,000 units
Finished goods in store 3 months
Raw material in store 2 months consumption
Production process 1 month
Credit allowed by creditors 2 months
Selling price per unit ₹50
Raw material cost 50% of selling price
Direct wages 10% of selling price
Overheads 20% of selling price
20% sales are on cash basis and credit sales are allowed to its customers for 1 month. Overheads
include ₹5 as depreciation. There is a regular production and sales cycle and wages and overheads
Chapter 11, Working Capital Management: 32
accrue evenly. Wages are paid in the next month of accrual and overheads are paid 15 days in
arrears. Material is introduced in the beginning of the production cycle. You are required to find out
its working capital requirement on cash cost basis.
(B. Com. Honors, Delhi University, 2013)

Solution
Let us calculate various components of the cost—
𝑅𝑎𝑤 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 50% ⇒ ₹50 × 50% ₹25
𝐷𝑖𝑟𝑒𝑐𝑡 𝑤𝑎𝑔𝑒𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 10% ⇒ ₹50 × 10% ₹5
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 𝑆𝑎𝑙𝑒𝑠 × 20% ⇒ ₹50 × 20% ₹10
Total ₹40
Profit ₹10
Selling price ₹50
Statement showing estimation of working capital requirement
Particulars ₹
2𝑀
Raw material 69,000 × 25 × 2,87,500
12𝑀
5 (10 − 5) 1𝑀
Work-in-progress 69,000 × (25 + + )× 1,72,500
2 2 12𝑀
3𝑀
Finished goods 69,000 × (25 + 5 + (10 − 5)) × 6,03,750
12𝑀
80 1𝑀
Debtors 69,000 × × (25 + 5 + (10 − 5)) × 1,61,000
100 12𝑀
Cash or bank balance to be maintained in the business --

Gross working capital/Total current assets (A) 12,24,750

2𝑀
Creditors 69,000 × 25 × 2,87,500
12𝑀
1𝑀
Wages 69,000 × 5 × 28,750
12𝑀
0.50𝑀
Overheads 69,000 × (10 − 5) × 14,375
12𝑀
Total current liabilities (B) 3,30,625
WORKING CAPITAL (A-B) 8,94,125
Add: Margin/Contingency --
REQUIRED WORKING CAPITAL 8,94,125

Chapter 11, Working Capital Management: 33