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WORKING CAPITAL
3)Overtrading
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WORKING CAPITAL MANAGEMENT
PROBLEM NO. 1:- Managing Director of A Ltd., wishes to know the amount of working capital
that will be required during next year. Production during next year will be 60,000 units. Expected ratios
of cost to sales price are Raw materials 60%, Direct Wages 10% Overheads 20%. Raw
materials will remain in store for an average of 2 months. While each unit is expected to be in process
for one month. Labour and Overheads cost will be accrued evenly during the year. Finished goods will
stay in warehouse for 3 months Credit allowed by Creditors is 2 months and for Debtors it is 3 months.
Sales price is Rs.5 per unit. Wages and Overheads are paid on the 1st day of each month for previous
month. Company keeps cash in hand to extent of Rs.20,000. There will be regular production and sales
cycle.
PROBLEM NO. 2:- B Ltd. is operating on single shift basis with the following cost structure.
Sales value during 1998-99, was Rs.43,000 and stock on 31.3.1999 was
Rs.
Raw material (at cost) 36,000
W.I.P (at prime cost) 22,000
Finished goods (at total cost) 72,000
Sundry Debtors 1,08,000
Company is proposing of working in double shift. It is expected that 10% discount will be
available from suppliers in view of increased volume. Sales price will remain same credit period allowed
to customers will also remain same. Credit available from supplier will remain at present level i.e. 3
months.
Lag in payment of wages and expenses will continue to remain half month.
Calculate working capital requirement for single shift and double shift.
PROBLEM NO. 3:- Following annual figures relate to XYZ company.
Company sells its product on Gross Profit of 25% considering depreciation as a part of
manufacturing cost. Company keeps one month stock of Raw Materials and Finished Goods and Cash
balance of Rs.1,00,000. Assuming 20% safety margin ascertain working capital requirement on cash
cost basis. Ignore WIP valued Finished goods at works cost.
PROBLEM NO. 4:- A Ltd. is commencing a new project for manufacturing of plastic
components. Following is the cost information for annual production of 12,000 units which is the fully
capacity.
Per unit
Materials at Rs.40 per unit 40
Direct Labour and variable expenses Rs.20
Fixed manufacturing expenses 6
Depreciation 10
Fixed administration expenses 4
80
Selling price per unit is expected to be Rs.96 and selling expenses Rs. 5 per unit (at full capacity).
80% of which are variable.
In first year production was 6000 units and sales was 5000 units. While in 2nd year it was 9000
units and 8500 units respectively.
Additional information:
1. Stock of material 2.25 months average consumption.
2. WIP – Nil
3. Debtors -- 1 months average sales.
4. cash balance Rs.10,000
5. Creditors for materials one month average purchases during year.
6. Credit for expenses 1 month average of all expenses during year.
Prepare projected statement of Profit & Loss A/c , ignoring taxation and statement of working
capital requirement for 2 years.
Rs.
Raw material 80 per unit
Direct Labour 30 per unit
Overheads 60 per unit
Profit 30 per unit
Sales price 200 per unit
Raw materials are in stock on an average one month. While materials are in process for half a
month. Finished goods are in stock for one month. Credit allowed by supplier is one month. Credit
allowed by supplier is one month and credit allowed to debtors is 2 month. Lag in payment of wages 1 ½
weeks, while of Overheads is 1 month, ¼ of output is sold for cash.
Cash in Hand is expected to be Rs.25,000. For WIP valuation, it can be assumed that it is 100%
complete as regards to material and 50% complete as regards to labour and overheads.
Calculate working capital requirement for operating level of 104000 units.
PROBLEM NO. 6:- Company sells goods on profit of 20% on sales price not considering
depreciation as a part of cost of goods sold. The yearly figures are as follows:
Rs.
Home sales of 1 month credit 12,00,000
Export sales at 3 month credit and sales price 10% below normal price
Material used (2 month credit) 5,40,000
Manufacturing expenses (1 month arrears) 4,50,000
Depreciation on fixed asset 5,40,000
Wages paid ( ½ month arrears) 60,000
Office expenses (1 month arrears) 3,60,000
Sales promotion expenses paid quarterly in advance 1,20,000
Income tax payable in 4 instalments of which one falls in next financial 60,000
year
1,50,000
Company keeps one month stock of raw materials and finished goods, Rs.1,00,000 in cash.
Company has facility of overdraft of Rs.50,000 and wishes to utilise it.
Assuming 15% safety margin and ignoring WIP calculate working capital requirement at end of
year.
Consider Debtors and Finished goods at cash cost.
PROBLEM NO. 7:- You’re the bank manager and have to finance manufacturing company
having level of core current assets of Rs.45,00,000. Calculate maximum permissible bank finance under
three 3 methods of Tondon Committee from company Balance Sheet .
Balance Sheet as on
Rs.in lacs Rs.in lacs
Equity Share Capital 300 Fixed assets 750
Retained earnings 300 Raw materials inventory 150
11% Debentures 450 WIP 225
Public Deposits 150 Finished goods 112.50
Trade Creditors 120 Debtors 150
Bills payable 150 Bank 82.50
Rs.in lacs Rs.in lacs
1470 1470
Public deposits are on long term basis. You are also required to calculate current ratios under 3
methods assuming that bank has allowed Maximum Permissible Bank Finance.
PROBLEM NO. 8:- As a finance manager you have to suggest, on debtors policy of the
company.
A new customer with 10% risk of non payment desires to establish business connections with
you. He would be required 1 ½ month credit and is likely to increase your sales by Rs.60,000 p.a. Total
costs amount to 80% of sales value. You are required to pay income tax at 50%. Should you accept his
offer if required rate of return is 40% after tax? Also state degree of risk of non-payment that you’ll
accept if required rate of return after tax was 30% and 20% respectively.
PROBLEM NO. 9:- Present level of sales of XYZ Ltd. is Rs.100 lacs. Its average collection period is
45 days. Marketing department feels that if credit is extended for 60 days, sales can be increased by
Rs.15 lacs. Contribution margin is 25% on sales. Accounts department estimates that if request of
marketing department is accepted collection expenses will increase by 1% of additional sales and
provision will have to be made for bad debts at 10% of additional sales. Company average cost of
capital is 12%. Assuming working days in year to be 360, calculate impact on profitability if extended
credit is allowed to new customer’s only and to all customers.
PROBLEM NO. 10:- A company has sales of Rs.10 lacs p.a. Average collection period is 50 days.
Bad debts 6% of sales and collection expenses Rs.10,000. The cost of funds is 15% p.a. Company
has two alternative collection programmes.
Particulars I II
Collection period reduced to 40 days 30 days
Bad debts losses reduced to 4% of sales 3 % of sales
Collection expenses 20,000 30,000
PROBLEM NO. 11:- A company is selling 400 components per month at rate of Rs.1,000 per
component. Variable cost per component is Rs.800. At present company grants one month credit to
customer and is thinking of extending some to 2 months which will result as below:
12)Declining profits
Overtrading
often occurs when companies expand its own operations too quickly.
Overtraded companies enter a negative cycle, where increase in interest expenses negatively impact
net profit leads to lesser working capital leads to increase borrowings leads to more interest expense and
the cycles continues. Overtraded companies eventually face liquidity problem and/or running out of
working capital.
Results of Overtrading
Tondon Committee
2)Major recommendations-
a)Bank finance essentially for meeting working capital needs. For other requirements, other sources
should be found.
IIIrd Method = 75% (Current Assets – Core Current Assets ) – Current Liabilites
c)Half yearly operational results in the form of Balance Sheet and Profit & Loss Account within two
months from the end of the half year.
d)Stock statements should be submitted on monthly basis. Basis of valuation in the stock statements &
balance sheet should be uniform.
e)physical stock verification if required.
Chore Committee
5)Concept of WCTL which could be made repayable in half yearly installments within definite period
which should not exceed five years.
6)Compulsory periodic review of Cash Credit limits (atleast once in year for limits above Rs 10 Lakhs )
8)Penalty for default in the submission of quarterly statements – (penal interest of 1 % per annum)
10)No additional facilities by the consortium banks in the case of default in submission of information
statements.