Definition of Working Capital Requirements
Your finance homework is not a problem with our help. First, the working capital (WC) is the excess of current assets (CA) over current liabilities (CL) and is calculated the following working capital requirements formula:
WC = CA-CL
Secondly, the working capital requirement is the needed funds for supporting daily operating activity.
Current assets consist of cash, debtors, and stocks which are divided by materials, work in progress and finished goods available for sale.
CA= Cash + Debtors+ Stocks,
Where:
Stocks = materials + work in process + finished goods
Current liabilities include the creditors, wages payable and accrued expense.
CL = creditors + wages payable + accrued expense
So, the formula of working capital requirements can be the following:
WC = (Cash + Debtors + Stocks) – (Creditors + Wages Payable + Accrued Expense)
Financing Working Capital Requirements on a Real Sample
The following information is available for your calculations:
(A) Per unit (Rs.):
Raw Materials 90
Direct Labour 40
Overheads 75
205
Profit 60
Selling price per unit 265
(B)
(i) Raw materials are in stock, on average one month.
(ii) Materials are in the process, on average 2 weeks.
(iii) Finished goods are in stock, on average one month.
(iv) The credit allowed by suppliers, one month.
(v) The time lag in payment from debtors, 2 months.
(vi) Lag in payment of wages, 1 1/2 weeks.
(vii) Lag in payment of overheads is one month.
20% of the output is sold in cash. Cash in hand and at a bank is expected to be Rs. 60,000. It is to be assumed that production is carried on evenly throughout the year; wages and overheads accrue similarly and a time period of 4 weeks is equivalent to a month.
Step 1. Calculation Stock of Materials, Work in Process, and Finished Goods
Calculation average stock of materials
Output annual = 156,000 units
Year in weeks = 12 months x 4 weeks = 48 week
Output weekly = Output annual/Year in week = 156,000/48 = 3,250 units
Stock of materials = Output monthly x Cost per Unit x Security Time
Average Stock of Materials = 3,250 x90 x4 weeks = 1,170,000 (Rs)
Calculation average stock of work in process
Working Process consists of direct materials, direct labor and overhead
Average Direct Materials = Output weekly x Cost per Unit x Period. Average Direct Materials = 3,250 x 90 x 2 = 585,000 (Rs)
Average Direct Labor = 3,250 x 40 x 2 = 260,000 (Rs)
Average Overhead = 3,250 x 75 x 2 = 487,500 (Rs)
Total Stock of Work in Process = 1,332,500(Rs)
Calculation average stock of finished goods
Stock of finished goods = output monthly x cost per unit x period or more detailed:
Average direct materials = 3,250 x 90 x 4 = 1,170,000 (Rs)
Average direct labor = 3,250 x 40 x 4 = 520,000 (Rs)
Average overhead = 3,250 x 75 x4 = 975,000 (Rs)
Average Stock of Finished Goods for 4-week period equal 2,665,000 (Rs)
Total Stocks will be the summary stock of materials, stock of work in process and stock of finished goods of 5,167,500 (Rs)
Step 2. Calculation Average Debtors
Average Debtors = Output weekly x Unit Cost x Debtors Period x Portion of Credit Sales
Average Debtors = 3,250 x 205x 8 x 4/5 = 4,264,000 (Rs)
Step 3. Calculation Average Current Assets
Average Current Assets are the summary the Total Stock, Debtors, and Cash required will be 9,491,500(Rs).
Step 4. Calculation Current Liabilities
- Average Creditors will be equals sum of the weekly materials used multiplied by credit period
Average Creditors = 3,250 x 90 x 4 = 1,170,000 (Rs)
- Average Wages Payable will be equal the weekly wages earned multiplied by lag of payment
Average Wages Payable=3,250 x 40 x 3/2 =195,000(Rs)
- Average Accrued Expenses will be equal the weekly accrued overhead multiplied by credit terms
Average Accrued Expenses=3,250 x 75 x 4 = 975,000(Rs)
Step 5. Calculation Average Current Liabilities
Total Average Current Liabilities equals summary above calculated items of 2,340,000(Rs)
Step 6. Calculation Working Capital Requirements
- Working Capital Required = Average Current Assets – Average Current Liabilities
Working Capital Required = 9,491,500 -2,340,000 =7,151,500(Rs)
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