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Explain percentage of sales method in estimation of working capital.
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.
| Assets | Amount ($) | Liabilities | Amount ($) |
|---|---|---|---|
| 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 −
| Particulars | 20XX figures | % of sales | Estimated |
|---|---|---|---|
| Sales | 900 | 100 | 1200 |
| Inventories | 60 | 6.67 | 80 |
| Accounts receivables | 90 | 10.00 | 120 |
| Cash | 30 | 3.33 | 40 |
| Current assets (X) | 180 | 20 | 240 |
| Accounts payable | 50 | 5.56 | 66.67 |
| Current liabilities (Y) | 50 | 5.56 | 66.67 |
| Working capital (X-Y) | 130 | 14.44 | 173.33 |
Updated on: 29-Sep-2020
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