Question

1. The following data relate to Bebe Ltd, a manufacturing company.

Revenue for the year Sh.1,500,000

Costs as percentages of sales %

Direct materials 30%

Direct labour 25%

Variable overheads 10%

Fixed overheads 15%

Selling and distribution 5%

On average:

(a) Accounts receivable take 2.5 months before payment.

(b) Raw materials are in inventory for three months.

(c) Work in progress represents two months' worth of half produced goods.

(d) Finished goods represents one month's production.

(e) Credit is taken as follows:

(i) Direct materials 2 months

(ii) Direct labour 1 week

(iii) Variable overheads 1 month

(iv) Fixed overheads 1 month

(v) Selling and distribution 0.5 months

Work in progress and finished goods are valued at material, labour and variable expense cost.

Required

Compute the working capital requirement of Corn Co assuming the labour force is paid for 50 working weeks a year

Answer 1

The formula to calculate working capital is as follows

Working capital = Current Assets – Current liabilities

The calculation is done using the following steps

Step 1: Calculation of annual costs

Firstly, let us calculate annual costs incurred

Direct materials = 30% of Revenue = 30% of $1,500,000 = $450,000

Direct labour = 25% of Revenue = 25% of $1,500,000 = $375,000

Variable overheads = 10% of Revenue = 10% of $1,500,000 = $150,000

Fixed overheads = 15% of Revenue = 15% of $1,500,000 = $225,000

Selling and distribution = 5% of Revenue = 5% of $1,500,000 = $75,000

Step 2: Calculation of average value of current assets

Let us calculate average value of current assets using the annual costs

Raw materials = 3/12 * $450,000 = $112,500

Work in progress:

Materials (50% complete) = 1/12 * $450,000 =$37,500

Labour (50% complete) = 1/12 * $375,000 = $31,250

Variable overheads (50% complete) = 1/12 * $150,000 = $12,500

Total work in progress = $81,250

Finished goods:

Materials = 1/12 * $450,000 =$37,500

Labour =1/12 * $375,000 = $31,250

Variable overheads = 1/12 * $150,000 = $12,500

Total Finished goods = $81,250

Accounts receivable = 2.5/12 * $1,500,000 = $312,500

Average value of Current assets = Raw materials + Total work in progress + Total Finished goods + Accounts receivable = $112,500 + $81,250 + $81,250 + $312,500 = $587,500

Step 3: Calculation of average value of current liabilities

Let us calculate average value of current liabilities using the annual costs

Materials = 2/12 * $450,000 = $75,000

Labour = 1/50 * $375,000 = $7,500

Variable overheads = 1/12 * $150,000 = $12,500

Fixed overheads = 1/12 * $225,000 = $18,750

Selling and distribution= 0.5/12 * $75,000 = $3,125

Average value of current liabilities = $75,000 +$7,500 + $12,500 + = $18,750 + $3,125 = $116,875

Step 4: Calculation of working capital

Using the above obtained values, let us now calculate the working capital

Working capital = Average value of current assets - Average value of current liabilities $587,500 - $116,875 = $470,625

Note:

Given that labour is paid for 50 weeks, the calculation of labour in current liabilities is taken in weeks instead of months.

It is assumed that all the direct materials are allocated to work in progress when the production starts.