Forecasting methods of working capital requirements

Working capital forecasting is a difficult task. The reason is that the total current assets requirements should be forecasted in estimating the working capital requirements. Working capital forecasting is based on the overall financial requirements and financial policies of the concern.

The basic objective of working capital forecasting is either to measure the cash position of the concern or to exercise control over the liquidity position of the concern. In this context, any one of the following methods can be adopted for working capital forecasting.

Working capital forecasting methods:

  1. Cash Forecasting Method.
  2. Balance Sheet Method.
  3. Adjusted Profit and Loss Method.
  4. Percent of Sales Method.
  5. Operating Cycle Method.
  6. Regression Analysis Method

1. Cash Forecasting Method

Total cash receipts and cash disbursement for a particular period are taken into consideration linder cash forecasting method. Cash receipts may be estimated cash sales, cash collected from debtors, and bills receivables, other miscellaneous cash receipts and sale of fixed assets and investments. Delay in cash receipts is taken into consideration.

Cash disbursement may be relating to estimated cash purchases, payment to sundry creditors, repayment of loan, payment over bills payable, payment of wages, salaries, bonus, advances, payable to suppliers, repayment of loans and advances interest and principal amount and the like. The minimum cash balance designed to be maintained is added with the required disbursements and provision is also made for additional borrowings and the like.

Both cash receipts and cash disbursements are recorded in a format. In this way, working capital is forecasted under cash forecasting method.

2. Balance Sheet Method

A balance sheet is prepared by adjusting the anticipated transactions for the ensuring year in the opening balances. The closing balances of all accounts are arrived other than cash and bank balances. The accountant has confirmed that all the assets and liabilities are balanced and recorded in the balance sheet. Lastly, closing cash and bank balances are arrived to find the working capital.

3. Adjusted Profit and Loss Method

Working capital is forecasted on the basis of opening cash and bank balances. Under this method, some of the items are added and some of the items are deducted to arrive closing cash and bank balances i.e. working capital. The items like depreciation, preliminary expenses written off, deferred revenue expenses, goodwill written off, reduction in closing stock, decrease in sundry debtors and bills receivable, decrease in investments and marketable securities, increase in sundry creditors and other liabilities, increase in loans and accrued expenses are added with opening cash and bank balances.

The items like accrued rent, accrued interest/Dividend/ Royalty, increase in closing stock, increase in sundry debtors, increase in investments, increase in bills receivables, decrease in sundry creditors, bills payable and other liabilities, payment of expenses of last year and payment of dividend are deducted from opening cash and bank balances. The net amount will be required working capital.

4. Percent of Sales Method

The existing relationship between sales and working capital is identified for one or two years. If the relationship is steady over a period of time, certain percent is fixed to determine working capital over the forecasted sales. The relationship between sales and working capital and its various components may be expressed in three ways:

  • as number of days of sales;
  • as turnover;
  • as percentage of sales.

This method is suitable for short period since the relationship does not vary for short period. Moreover, this method is not suitable for public limited companies and multinational corporation.

5. Operating Cycle Method:

The operating cycle refers to the period required to convert the cash back into cash. In the case of trading concern, cash is used to buy goods, goods are sold on credit to customers who become sundry debtors, the sundry debtors may accept bill of exchange i.e. Bills Receivable, conversion of bills receivable into cash. At this stage, one operating cycle is completed. Thus, a loop from cash back to cash is called the “Operating Cycle“.

The following formula may be used to express the frame work of the operating cycle:

T = (r-c)+w+f+b


t = The total period of the operating cycle in number of days.

r = Number of days of raw material and requirements of stores consumption held in raw materials and stores inventory.

c = Number of days of purchases in trade creditors.

w = Number of days of production held in work in progress.

f = Number of days of cost of sales held in finished goods inventory.

b = Number of days of sales in book debts.

The computations may be made as under

r = (Average inventory of raw materials and stores / Average per day consumption of raw materials and stores).

c = (Average Trade Creditors / Average Credit Purchase per day).

w = (Average work in progress / Average cost of production per day).

 f = (Average inventory of finished goods / Average cost of sales per day).

b = (Average book debts / Average sales per day).

The average inventory, work in progress, trade creditors, book debts and finished goods can be computed by adding the opening balance and closing balance in the respective accounts at year end and dividing it by two.

5. Regression Analysis Method.

Under this method, an average relationship between sales and working capital (current assets) and its various components has been established for the past years. Regression analysis can be carried out through the graphic portrayals (scatter diagrams) or through mathematical formula. There are three regression analysis methods. They are simple linear regressions, simple curvilinear regression and multiple regression situations. The working capital can be forecasted with this regression analysis method even for the complex situations. It is particularly suitable for long term forecasting.

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