Page 36 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 2: Planning of Working Capital

Work-in-Process (W/P) Inventory: The relevant costs to determine work-in-process inventory Notes
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-process would be higher, that is, cost of full
unit + 50 per cent of conversion cost, compared to the raw material requirement throughout the
production cycle; W/P is normally equivalent to 50 per cent of total cost of production.
Symbolically,

Estimated work-in-
Budgeted production Average time span or
(in units) × process cost per unit × work-in-progress
inventory
(months/days)

12 months/365 days

Finished Goods Inventory: Working capital required to finance the finished goods inventory is
given by factors summed up in 12 months/365 days
Debtors: The WC tied up in debtors should be estimated in relation to total cost price

Cost of sales per unit
(excluding
Budgeted Credit Average debt
sales (in units) × depreciation) × collection period
(months/days)

2 months/365 days

Cash and Bank Balances: Apart from WC needs for financing inventories and debtors, firms
also find it useful to have some minimum cash balances with them. It is difficult to lay down the
exact procedure of determining such an amount. This would primarily be based on the motives
for holding cash balances of the business firm, attitude of management toward risk, the access to
the borrowing sources in times of need and past experience, and so on.

Estimation of Current Liabilities

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

Trade Creditors Credit period
Budgeted yearly × Raw material cost × allowed by creditors
per unit
production (in units) (months/days)

12 months/365 days

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

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