Explain percentage of sales method in estimation of working capital.

Banking & FinanceFinanceFinance Management

Percentage of sales method is the traditional method to find out working capital. This method is based on historical relationship between sales and working capital. Each of historical value is converted to percentage of net sales and those values are used to forecast.

Steps involved in this method are −

  • Determine historical relationship between sales and working capital.
  • Forecast sales for future date.
  • Apply percentage sales of method to get forecasted value.

Formula

Percentage of sales method = WCc*100/S
Here WCc = components of working capital, S = yearly sales

Advantages of this method are −

  • Easy to understand.
  • Calculations are simple.

Disadvantages of this method are −

  • Relationship between sales and working capital should be linear.
  • Calculations depends on sales forecast.

Example

  • Sales for 20XX are $900 and forecasted sales are $ 1200. Below is the balance sheet for the year 20XX.

AssetsAmount ($)LiabilitiesAmount ($)
Owners fund
Debentures
Accounts payable
300
130
50
Fixed capital
Inventories
Accounts receivable
Cash
200
60
90
30

480
440

Solution

The solution is given below −

Particulars20XX figures% of salesEstimated
Sales9001001200
Inventories606.6780
Accounts receivables9010.00120
Cash303.3340
Current assets (X)18020240
Accounts payable505.5666.67
Current liabilities (Y)505.5666.67
Working capital (X-Y)13014.44173.33
raja
Published on 29-Sep-2020 17:27:48
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