Procedures to forecasting Working Capital

What are the procedures to forecasting working capital?

The following procedure is adopted for estimating working capital.

  1. Calculating the value of total current assets.
  2. Calculating the obligation of total current liabilities.
  3. Ascertainment of net working capital requirements i.e. the difference between the value of total current assets and the obligation of total current liabilities.
  4. Sum up the contingencies along with net working capital if any.

1. Calculating the value of Total Current Assets

The following are the components of current assets. The points to be considered in the valuation of each current assets are briefly explained below.

1. Stock (Inventory): It includes the stock of raw materials, stock of work in progress and stock of finished goods. The stock of raw materials are valued at purchase price. The stock of work in progress is valued at the stage of completion of production. The stock of finished goods is valued at the total cost of the goods.

2. Debtors: It is calculated by taking into consideration of period of credit allowed and volume of credit sales.

3. Outstanding Income: The lag in receipt of rent, interest etc (Accrued Interest) should be estimated properly.

4. Prepaid Expenses: Sometimes some expenses may be paid in advance in order to maintain flow of operation properly. Such expenses may be wages, salaries, commission, insurance etc.

5. Bills Receivable: The sundry debtors may accept bill of exchange. In this case, the period of bill of exchange and the value of bill are taken into consideration for working capital forecasting.

6. Marketable Securities: Short term investments may be made by the company. If so, value of investments and the time taken for marketing are considered for working capital forecasting.

7. Cash and Bank Balance: Cash in hand, cash at bank and fixed deposits are considered as cash and bank balance. A minimum balance of cash is maintained in hand and at bank to meet the payment for wages, salaries and other day to day operating activities.

2. Calculating the obligation of Total Current Liabilities

The following are the components of current liabilities. The points to be considered in the estimation of obligation of each current liabilities are briefly explained below.

1. Sundry Creditors: It is estimated on the basis of total value of credit purchase and the credit period allowed by the suppliers.

2. Bank Overdraft: The quantum of bank overdraft required for a period is estimated on the basis of period and amount.

3. Outstanding Expenses: All the expenses can not be paid immediately. Some expenses are payable at frequent intervals. Such expenses are treated as outstanding expenses at the end of the period. The total expenses in a year and the lag in payment of such expenses are considered for working capital forecasting.

4. Income Received in Advance: Some income may be received in advance by the company. Income such as rent, commission etc might have been received in advance. Out of the total income, how much of income is received in advance by considering the period of income received in advance are considered for working capital forecasting.

5. Bills Payable: A company can accept the bill of exchange for credit purchase. The period of bill of exchange allowed by the supplier and the value of bill are considered for working capital forecasting.

6. Unsecured Loans: A company can get credit facility from banks without giving any security for short period. This type of loan is treated as unsecured loans. Such loans may be repaid within one year. In this case, the amount of unsecured loan and the time required for repayment are considered for working capital forecasting.

7. Public Deposits: A company can get deposits from public and repayable within one year. In this case, the average period required to repay the public deposits and value of public deposits are considered for working capital forecasting.

3. Ascertainment of Working Capital

The obligation of total current liabilities are deducted from the value of total current assets to find the requirements of net working capital. Generally, the value of current assets is more than the current liabilities. If not so, there is no working capital.

4. Adding of Contingencies

The arrived net working capital may not be a final. If the management feels to add some amount for contingencies, such as an amount can be added with net working capital for gross working capital requirements.

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