Working Capital Calculation – Percentage of Sales Method

Percentage of sales method is a working capital forecasting method which is based on past relationship between sales and working capital. Just like technical analysis in the stock market, it assumes that the history will repeat itself and thus the ratio of working capital to sales will remain constant. In other words, it assumes that the whole business will move in tandem with sales.

How to Calculate Working Capital Using Percentage of Sales Method?

Percentage of sales method is the simplest and easiest way of finding future working capital. First, each component of working capital as a percentage of sales is calculated. Like, accounts payable are 20 million, and sales are 100 million, accounts payable as a percentage of sales would be 20%. Secondly, the coming year sales forecast is taken as a base and the component is calculated as per the percentage. In our instant example, if forecasted sales are 150 million, accounts payable should be 30 million. This is as simple as that. Let us see a practical example with formula and example.

Percentage of Sales Method Formula = Component of Working Capital * 100 / Sales of the Year

Percentage of Sales Method Example

Consider following balance sheet for the year 2014 as an example. The sales for 2014 are $400. The forecasted sales figure for the year 2015 is $600.

Assets Amt. ($) Liabilities Amt. ($)
Owner’s Capital

200

Fixed Assets

170

Debentures

110

Inventories

40

Accounts Payable

40

Accounts Receivables

110

Cash and Bank

20

 

350

 

290

Percentage of sales method will calculate the working capital and its components as illustrated in the below table. We can see that in the last column, estimates for 2015 are calculated and the working capital requirement for 2015 comes out to be $195 for the forecasted sales figure of $600.

Particulars

 

Actual Figures

of 2014

% of Sales

Estimate for

2015

Sales

400

100

600

 
Current Assets (x)

170

42.5

255

Inventories

40

10

60

Accounts Receivables

110

27.5

165

Cash and Bank

20

5

20

Current Liabilities (y)

40

10

60

Accounts Payable

40

10

60

Working Capital (x-y)

130

32.5

195

Advantages and Disadvantages of Percentage of Sales Method

Advantages of this method are that it is easy to understand and simple to calculate. There is not rocket science in calculating the working capital based on this method.

The biggest disadvantage is its assumption which is not very practical in all situations. This method is useful only where the relation between the revenue and working capital is linear. Elsewhere this method is not suggested. Another drawback is that it is highly dependent on sales forecast. If the sales forecast is faulty, a whole calculation will be faulty. Higher working capital would attract higher interest cost and low profitability and lower working capital would pose a problem to the smoothness of the operating cycle.

Other Methods for Estimating the Working Capital Requirements

Operating Cycle Method

Regression Analysis Method

Last updated on : August 1st, 2017
What’s your view on this? Share it in comments below.

Leave a Reply

Types of Working Capital
  • Methods for Estimating Working Capital Requirement
    Methods for Estimating Working Capital Requirement
  • Advantages of Trade Credit
    Advantages of Trade Credit
  • Working Capital Management - Maturity Matching or Hedging Approach to Working Capital Financing Graph
    Maturity Matching or Hedging Approach to Working …
  • Working Capital Financing
    Working Capital Financing
  • Subscribe to Blog via Email

    Enter your email address to subscribe to this blog and receive notifications of new posts by email.

    Join 122 other subscribers

    Recent Posts

    Find us on Facebook


    Related pages


    inventory turnover measuresfinancial accounting depreciation methodscalculating nopatforeign exchange transaction risknon discounted payback perioddebtor days calculationfnb overdraft facilityexamples of fixed cost and variable cost in manufacturingbenefits of payback periodhow to calculate irr in financedifference between shareholder and stockholderwealth maximization and profit maximizationirr method of capital budgetingdebits and credits definitiondefinition of lessor and lesseehow to account for capital leasesfactors of macro environmentdebits and credits explainedletter of credit payable at sightdisadvantages of break even analysispayback period calculation examplesfinancial accounting versus managerial accountingdefine invoice discountinghypothecated meaning in hindidupont formula calculatorconstant growth stock valuationhypothecated meansmeaning of venture capital in hindidefinition of standby letter of creditcostdriversmeaning of lease in marathidirect cost vs indirect costaccounting for research and development gaapdefinition of bank overdraftconstraints defadvantages of conglomerate diversificationdifference between financial accounting and auditingdays sales in inventory formulaborrowed capitalnovated lease vs hire purchaseinventory to sales ratio formulatypes of documentary creditsdebenture definehow to calculate irr manually examplemotives of mergerfinweb.comcapital budgeting formulalessor or lesseewho are preference shareholdersselling price variance formuladifference between net income approach and net operating income approachvariable cost examples in accountingroa formulafixed assets turnover ratio calculatortrade creditors definitionmultiple growth model formulastockholders equity meaningaccounts receivable to total assets rationet fixed asset turnoverinterpretation of debt equity ratiowhat are debentures and bondsmodigliani miller proposition 1roe ratio formuladefine zero based budgetingfactoring accountingdupont equation exampleadvantages and disadvantages of letter writingaccounts receivable turnover calculatormanagerial uses of variance analysiswhat is the breakeven formula