Page 150 - DMGT409Basic Financial Management

Unit 8: Working Capital Management

Solution: Notes

Estimation of working capital needed

Particulars Amount (Rs) Amount (Rs)
A. Estimation of Current Assets:
i) Raw materials inventory: One month: (1,10,000 x 78 x 4/52) 6,60,000
ii) Work-in-process inventory: Half a month
Raw materials (1,10,000 x 78 x 2/52) = 3,30,000
Direct labour (1,10,000 x 14.5 x 2/52) = 61,346.15
Overheads (1,10,000 x 29 x 2/52) = 1,22,692.31 5,14,038.46
iii) Finished goods inventory: One month: (1,10,000x165x4/52) 13,96,153.85
iv) Debtors: Two months: (82,500 x 165 x 8/52) 20,94,230.77
v). Cash balance required 2,15,000
Total Current Assets 48,79,423.08
B. Estimation of Current Liabilities:
i) Creditors: One month: (1,10,000 x 78 x 4/52) 6,60,000
ii) Expenses:
Overheads (1,10,000 x 58 x 4/52) = 4,90,769.23
Labour (1,10,000 x 29 x 3/104) = 92,019.23 582,788.46
Total Current Liabilities 12,42,788.46
C. Working Capital(A-B) 36,36634.62
Add: 10% Contingency 3,63,663.46
D. Working Capital Required 40,00,298.08

8.5 Sources of Working Capital

There are three financing policies vis-à-vis to financing current assets. Adoption of the specifi c

policy is left out to the firm. The three financing policies are:

1. Short-term Financing: Generally current assets should be financed by only short-term

financial sources. Short-term finance is obtained for a period of less than one year. The

sources of short-term finance are loans from banks, public deposits, commercial papers,
factoring of receivables, bills discounting, retention of profi ts etc., a fi rm, which required

short-term finance, can go for any one of these sources. In other words, a firm that required

short term finance can raise through any one of the sources.
2. Long-term Financing: Net current assets or permanent current assets or working capital
are supposed to be fi nanced by long-term sources of fi nance. Long-term fi nance is raised

for a period of more them five years. Long-term finance sources include, ordinary share
capital, preference share capital, debentures, long-term loans from bankers, and surpluses

(includes retained earnings). A firm that needs to finance net current assets can go for any

of these sources, but it depends on company’s attitude towards risk or control over the
company, companies earnings, capacity and period of loan reserved.
3. Spontaneous Financing: It refers to the automatic sources of short-term funds arising in the
normal course of a business. The source includes trade credit (suppliers’) and outstanding

expenses. Spontaneous sources of finance is available at no cost. A firm that wishes to
maximize owner’s wealth, it must and should utilize these sources to the fullest extent.
The real choice of fi nancing current assets, is between short–term and long-term sources.

In other words, some extent of current assets can be financed with the use of spontaneous
source, and the requiring current assets should be financed with the combination of long-

term and short-term sources of fi nance.

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