WORKING CAPITAL APPRAISAL METHODS

WORKING CAPITAL APPRAISAL METHODS

    In a life of Business finance is very important for expansion of business for daily routine expense like sales, purchase, direct and indirect expense like salary, electricity, travelling etc.  Working capital is very important source of finance for all routine expense of Operating Cycle of Business. Operating Cycle refers to the duration require by business to transfer non cash items into cash. Working capital is difference between Current assets and Current liability.

   Current assets refers to any assets which can be transferred into consideration with in current financial year it includes inventory , bills receivables , bank ,cash , prepaid expense , investment short term in nature. Whereas Current Liability refers to liabilities of business which can clear within one year or one cycle life of business

  

    Usually enterprises take short term loan to meet there financial need for business in this article we are going to discuss two Working Capital appraisals Cash Budget Method, and Turn Over Methods

Cash Budget Method,

     Cash Budget Method depends on the inflow and out flow cash of a business. Some business are  cyclic and seasonal type of business like construction , sugar ,tea, contractors film industry , exports or order base  where sales order comes more but cash realization  for such sales or incoming cash flows for such sales are very slow therefore . Bank gives short term Working Capital loan for such kind of industries on Cash Budget Method. In this method bank will see cash flow of 2 periods one is actual and one is projected of business to determine the Surplus / deficit cash flow of firm   this method  explain with help of below example 

  

	APR	MAY	JUN	JUL	AUG	SEP	OCT	NOV	DEC	JAN	FEB	MAR
Opening Cash Balance	30	40	40	40	40	40	40	40	40	40	40	40
Add - Cash Receipts	180	225	200	220	210	220	215	180	210	220	215	225
Less - Cash Payment.	170	180	170	250	200	210	180	165	215	208	202	210
Closing Balance	40	85	70	10	50	50	75	55	35	52	53	55
Balances To Be Maintain	40	40	40	40	40	40	40	40	40	40	40	40
Surplus/ deficit	0	45	30	-30	10	10	35	15	-5	12	13	15

 

     Above table is the example of the Cash Budget Method. In this table total one year cash flow are given which is require for Cash Budget Method. Starting month is April and last month is March total twelve months cash flow given. IN the month of April opening balance is 30 ( figures in lakhs) cash receipts for the months 180 lakhs and cash payment is 170 closing balance is 40 here balance of cash to be maintain  is 40 lakhs so surplus or deficit is 0 in the second column same process is continue where surplus is 30 lakhs in all twelve months cash deficit is (30 lakhs ) in the month of July so in that month more cash require for  firm so it is consider as working capital for the firm This is called the Cash Budget Method .  Bank consider drawing power also while calculate working capital by Cash Budget Method

     In this  Cash Budget Method   it is important to understand flow of cash  that is incoming cash and outgoing cash  of firm which will decide deficit / surplus  Bank officer has to be very alert for find out the real working capital require by firm

Operating Cycle Method     

      Operating cycle method is one of the working capital appraisal method .Operating cycle   Method refers to the “duration require by business to transfer non cash items into cash” .

     

    This process starts from purchase of raw material from suppliers, then it will go for manufacturing process which is also known work in process, then it will convert into finished goods then next process is finished goods dispatch to debtors as per order on credit or cash basis. This process is known as sales of goods. Sales get transferred into cash after due date then creditors get paid for purchase of material  

    Operating Cycle Method explain with following diagram

    Purchase à Raw Material à Process à Finished Goods à Sales To Debtors à Debtors gives payment à Paid to creditors

     As per mention in the above every process in the operating cycle takes some time for example purchase of raw material takes around 30 days then it get convert into finish goods takes around 10 days finish goods dispatch to sundry debtors takes around 20 days and payment comes from debtors takes around 30 days and to pay creditors around 30 days

     In above paragraph we see the actual time take in each and every process base on that we can calculate. Operating cycle following is the formula for operating cycle

Operating cycle = RM + WIP +FG +DEBTORS – CREDITORS

Here time taken for Raw Material consume from Creditors   = 30 days

Work in process (Raw Material convert into finish goods )    = 10 days

Finished goods sales to debtors (goods dispatch)                = 20 Days

Payments Receive from debtors                                            = 30 Days

Payments Paid to Creditors                                                    = 30 Days

     Formula for Operating cycle   =  RM + WIP +FG +DEBTORS – CREDITORS

                                               =  30 days + 10 days +20 days +30 days – 30 days

                                               =  60 Days

     Therefore the time taken for each operating cycle is 60 days

     Total operating cycles done in a year = No of days in year    

                                                                   Days require for each cycle

                                                                 =  365       

                                                                     60

    Total operating cycles done in a year   =   6

    So in a year 6 operating cycles done

   Now question is how to calculate Working Capital suppose here annual turnover is 150 lakhs operating expense is 120 lakhs Annual turnover is term as total sales done in a financial here it is 150 lakhs . Operating expenses is the expense which incurred in process of total operating cycles here it is  120 lakhs

    Formula for working capital requirement for

operating cycle method                             = operating expense In financial year

                                                                    Total no of operating cycles in year

                                                                  = 120l

                                                                        6  

                                                                   = 20L

     It menace working capital estimation per 2 months is 20 lakhs and per month is 10 lakhs          

  

     Operating cycle method is the very important method as per real market conditions, it gives the details information of business and very easy method in working capital apprise

    The limitations of this method is that it Is very long method while applying this method we have to consider a lot of things some times it may happen that data collect in this method may be different from actual  so it may disturb the process . Bank credit officer has to be very careful while checking bank finance by this method