Corporate Finance

Estimation of Working Capital 
 273

Operating cycle is also called cash-to-cash cycle. At any given point in time, a firm will have several
operating cycles at various stages of completion.

No. of operating cycles in ayear

Total expected operating expenses for the year

Total working capital=

Operating cycles will be relatively long in construction and machine tool business and relatively short in
trading companies.
To illustrate, if

Raw material holding period = 40 days

Conversion time = 10 days

Finished goods storage period = 15 days

Average collection period = 30 days

Operating cycles = 40 + 10 + 15 + 30 = 95 days. This means that there are (365/95) 3.84 operating cycles
in a year.
If operating expense is Rs1 crore,

Working capital requirement =

(365/95)

1 crore

= Rs 26 lac

As is evident from the above illustration, working capital is a function of operating expenses and length of
operating cycles. Reducing either of them (or both) will lead to reduction in working capital requirement and
hence increases efficiency. To illustrate, if the operating cycle is reduced to 75 days, the working capital turn-
over ratio would be (365/75) 4.80.

So, working capital requirement =

4.80

1 crore

= Rs 21 lac

Managing the components of the operating cycle, viz., raw material holding period, conversion time, finished
goods storage period, and average collection period more efficiently can reduce operating cycle.
If the accounts payable period is included we get net operating cycle.

Net operating cycle = Operating cycle time – Average payables period

The calculation involved in the estimation of the components of working capital is shown in Appendix 2.

An Illustration

Whirlpool of India Ltd is a manufacturer of refrigerators, deep freezers, and compressors. Shown here is the
estimation of net working capital cycle for Whirlpool.