Working Capital Management^185
The operating cycle is the time period from inventory purchase until the receipt of cash.
(Sometimes the operating cycle does not include the time from placement of the order
until the arrival of stock.) The cash cycle is the time period from when cash is paid out,
to when cash is received.
Computation of Working Capital
The two components of working capital (WC) are current assets (CA) and current
liabilities (CL). They have a bearing on the cash operating cycle. In order to calculate
the working capital needs, what is required is the holding period of various types of
inventories, the credit collection period and the credit payment period.
Working capital also depends on the budgeted level of activity in terms of production/
sales. The calculation of WC is based on the assumption that the production/sales is
carried on evenly throughout the year and all costs accrue similarly. As the working
capital requirements are related to the cost excluding depreciation and not to the salt
price, WC is computed with reference to cash cost. The cash cost approach is
comprehensive and superior to the operating cycle approach based on holding period
of debtors and inventories and payment period of creditors. Some problems have been
solved, however, using the operating cycle approach also. The steps involved in
estimating the different items of CA and CL are as follows:
Estimation of Current Assets
Raw Materials Inventory The investment in raw materials inventory is estimated on
the basis of Eq. l.
Budgeted Cost of raw Average inventory
production ◊ material(s) ◊ holding period
(in units) per unit (months/days)
12 months/365 days (1)Work-in-Process (W/P) Inventory The relevant costs to determine work-in-process
inventory i are the proportionate share of cost of raw materials and conversion costs
(labour and manufacturing overhead costs excluding depreciation).í 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,
Budgeted Estimated work Average time span
production ◊ in-process cost ◊ of work-in-progress
(In units) per unit inventory (months/days)
12 months/365 days (2)