Question

Eugen-Kay Construction Co. Ltd. expects credit sales of ¢24million in the next year and has budgeted production costs as follows:

¢million

Raw materials 4

Direct labour 5

Production overheads 3

Total production costs 12

Raw materials are in stock for an average of three weeks and finished goods are in stock for an average of four weeks. All raw materials are added at the start of the production cycle, which takes five weeks and incurs labour costs and production overheads at a constant rate. Suppliers of raw materials allow five weeks’ credit, whereas customers are given six weeks to pay. If production takes place evenly throughout the year, what is the total working capital requirement?

NB: Assume Work-in Progress is 50% complete at any point in time, 365 days a year and 52 weeks in a year.

You are required to compute the following for Eugen-Kay Construction Co. Ltd.:

i) Estimated Working Capital Requirement for the year;

ii) Cash Conversion Cycle.

Answer 1

$m

Credit sales

24

Raw Material

4

Direct Labour

5

Production OH

3

Total Production Cost

12

Work in Progress Cost

6

(50% of Production Cost)

Finished Goods-(Cost of Sales)

6

50%

$'m

Raw Materila Holding Period

3

weeks

21 days

Raw Material

0.2

(Raw material Holding Period/365)X Raw Material Cost

WIP holding Period

5

weeks

35 days

Work In Progress

0.6

(WIP Holding Period/365)X WIP Cost

Finished Goods Holding Period

4

weeks

28 days

Finshed Goods

0.5

( Finished Holding Period/365)X Finished Goods Cost

Average Receivable Period

6

weeks

42 days

Averge receivables

2.8

(Average receivable days/365)X Credit Sales

18

Currebt Asset

4.0

Less:

Accounts Paybale Period-Raw Material

5

weeks

35 days

Avergae Payable-Current Liability

0.6

(Average Payable days/365)X Cost of Sales)

Cash Converion Cycle

13

Working Capital

3.5

(Current Asset-Current Liability)

Cash Convertion Cycle=Raw Material Holding Period+WIP Holding Period+Finished Goods Holding Period+Average

Receivable Period-Accounts Payable Period