Estimating Working Capital Needs
The most appropriate method of calculating the working capital needs of a firm is the concept of operating cycle. However, a number of other methods may be used to determine working capital needs in practice. We shall discuss here three approaches which have been successfully applied in practice :
- Current assets holding period to estimate working capital requirements on the basis of average holding period of current assets and relating them to costs based on the company’s experience in the previous years. This method is essentially based on the operating cycle concept.
- Ratio of sales To estimate working capital requirements as a ratio of sales on the assumption that current assets change with sales.
- Ratio of fixed investment To estimate working capital requirements as a percentage of fixed investiment.