Working Capital Formulas

Working Capital Formulas

Some important working capital formulas have been given formula. These formulas have been further explained with easy examples in my other articles. Working capital is current asset minus current liabilities. The following ratio is important working capital

1.   Current Ratio

2.   Quick Ratio

3.   Debtor Collection period

4.   Debtor Turnover Formula

5.   Creditor Payment period

 Current Ratio Formula

Current ratio is calculated to describe the liquidity position of the company. A health current ratio explains the company ability to make future payment. Current ratio is calculated by the following formula.

Current Ratio =   Current Asset      .                                Current Liabilities

Current Ratio Formula Example

Closing Stock = 50,000

Closing Debtor= 30,000

Cash              = 20,000

Closing Creditor= 20,000

Calculate Current Ration

Solution

Current asset

Closing Stock =  50,000

Closing Debtor= 30,000

Closing Cash =   20,000

                        100,000

Current Ratio =   Current Asset   

                         Current Liabilities

=100,000/20,000

=5:1 (current asset are 5 times to current liablities)

Quick Ratio Formula

Quick ratio is another important liquidity ratio. Quick ratio is further extension of current ratio. Quick ratio gives more clear idea about the liquidity position of the company.

Quick Ratio =   Current Asset -Stock   .                                Current Liabilities

Quick Ratio Formula Example

Stock in Hand = 50,000

Debtor           = 30,000

Cash               = 20,000

Creditor          = 30,000

Calculate Current Ratio of the company

Solution

Current asset

Stock = 50,000

Debtor= 30,000

Cash =  20,000

          100,000

Quick Ratio =   Current Asset-Stock   

                        Current Liabilities

=(100,000-50,000)/30,000

=50,000/30,000

=1.666:1 (Quick asset are 1.66 times than current liabilities)

 Debtor Collection Period Formula

Debtor collection period is calculated by dividing the Debtor by the credit sales. The calculation has been explained in my other article.

Debtor Collection Period Formula  =   Debtor or Average Debtor x365                                                                          Credit Sales

Debtor Collection Days Formula Example

Credit Sales =500,000

Account Receivable Balance        = 50,000

Calculate Debtor collection period

Solution

Debtor Collection Period =   Receivable or Average Receivable x365  

                                                  Credit Sales

= (50,000/500,000) x 365

=36.5 days Days

Debtor Turnover Formula

Debtor Turnover shows how many times sales made to the customer and payment received from them. Debtor turnover ratio is calculated by dividing credit sales by receivable. Debtor Turnover calculation has been explained in my other article.

Debtor Turnover Formula =   Credit Sales                                                       Receivables

Debtor Turnover Formula Example

Credit Sales                             = 250,000

Receivables or average Sales =      50,000

Calculate Debtor Turnover?

Solution

Debtor Turnover Formula =          Credit Sales    

                                                   Receivables

= 250,000/50,000

= 5

The above example shows that company has collected the payment from the customer 5 times.

 Creditor payment Period Formula

Creditor payment period simply explains creditor average time of payment. Companies prefer to recover the payment as soon as possible.

Creditor payment Period =   Average Creditor x365                                                    Cost of Sales

Creditor Payment Period Formula Example

Cost of Sales     =900,000

Creditor or Average Creditor= 90,000

Calculate Creditor payment period

Solution

Creditor payment Period =   Average Creditor x365  

                                           Cost of Sales

= (90,000/900,000) x 365

=36.5 Days (Average Payment period)

Dividend Formulas

Dividend Formulas

Dividend is an important aspect of equity market (stock market) investment. Therefore dividend is used in couple of important calculation i.e. share price valuation, cost of equity etc. Dividend formulas for various calculations have been given below.

Share Valuation (Zero Dividend Growth) Formula

The following formula is known as dividend discount model. Share value is determined by discounting the future dividend using the cost of equity as discounting factor. This basic concept of dividend discounting has been further classified into two formulas i.e. Dividend without Growth and dividend is growing at constant pace).

Share Price = Do                                 Ke

Do= Dividend

Ke= Cost of equity

Share Valuation Example (Zero Growth of Dividend)

Dividend (Current Year) = .9

Dividend Growth Expectation = No Growth

Cost of equity=13%

Solution

=.9/.13

=6.92 (Share Price)

 Share Valuation (Constant Dividend Growth) Formula

Share Price = Do ( 1+g)                                    Ke-g

Do= Dividend

Ke= Cost of equity

g= Dividend Growth

Share Valuation Example (Constant Growth)

Current year announced dividend = .9

Dividend Growth Expectation   =    5%

Cost of equity=13%

Solution

Share Price = Do ( 1+g)        

                       Ke-g

Do=Current Dividend

Ke =Cost of equity

g= Dividend Growth

Share Price = .9(1+5%)

                     13%-5%

Share Price = .9(1+05)

                       .08

Share Price = 11.8

Cost of Equity – (Zero Growth or Constant Dividend)

The following formula is used to calculate Cost of equity, where there is zero growth of dividend.

Cost of Equity =    Do                                    Po

Do= Dividend

Po= Market Share price

Constant Dividend and Cost of Equity

ABC Company Dividend = .7

Nature of Dividend= Constant

Quoted Price = 12

Solution

Cost of Equity = Constant Dividend          

                        Ex Div Market Price

Cost of Equity = .7

                        12

=5.8%

Cost of Equity (Constant Growth of Dividend)

Dividend discount model can be used to calculated cost of equity of company. The following formula is used to calculate cost of equity for constant dividend growth. This formula cannot be used for negative and random dividend growth.

Cost of Equity =[Do (1+g)] + g                                   Po

g = Dividend growth Rate

Ke = Cost of Equity

Do =Current Dividend

Po= Share price

Cost of Equity Example (Constant Growth of Dividend)

Dividend for the Year = .7

Growth rate of Dividend (Expected)   = 9%

Share price= 20

Solution

Cost of Equity =[Do (1+g)] + g                                   Po

Do=Current Dividend

Ke =Cost of equity

g= Dividend Growth

Share Price = .7(1+9%)   + 9%

                          20

Share Price = .7(1+.09) + 9%

                          20

Share Price = 12.81%

Dividend Payout Ratio Formula

Dividend payout ratio show the proportionate of earning distributed among the equity holder of shareholder. This concept has been explained in detail in my other article. Dividend payout ratio is calculated simply by dividing the dividend by the EPS (Earning per Share).

Dividend Payout Ratio =            Dividend      x100                                                        EPS

Dividend Payout Formula Example

Dividend Announced = 50 cent

Earnings per Share   = 80 Cent

Calculate Payout ratio of the company?

Solution

Dividend Payout Ratio =            Dividend during the year    

                                                     EPS or Earning

Company A = .5  x 100  

                     .8

=62.5%

Dividend Yield Formula

Dividend yield explains the return on the investment in the form of dividend. This is useful tool for many investors.

Dividend Yield =      Dividend During Year                                       Share Market Price

Dividend Yield Formula Example

Dividend Paid =8

Market Price of Share = 30

Dividend Yield?

Solution

Earning Yield = 8

                      30

= 24%

Ex Divided Share Price Formula

Ex dividend share price formula is used to calculate the share price before the payment of dividend. The ex dividend share price concept is used in dividend discount model for calculating the cost of equity. Ex Dividend price is simply calculated by excluding dividend to be paid from the share price.

Ex Dividend Price = Share Price b- Dividend (to be paid)

Ex Div Price Formula Example

Share Price (Market value) = 12

Dividend for Year = 4

Calculate Ex Div Price?

Solution

Ex Div Price = Share Price before Dividend- Dividend (to be paid)

= 12-4

=8 (Ex Div Price)

Gordon Dividend Growth Formula

Gordon dividend growth formula establishes a relationship between retention of profit and future growth of dividend (direct relationship).  Gordon says that in case of high retention of profit would result in high growth of dividend. This relationship has been explained in detail in my other article.

g=br

g= Dividend Growth

b= Profit retention proportion

r= Cost of equity

Gordon Dividend Growth Model Example

Profit Retention propionate= 60%

Cost of equity = 12%

Solution

= 60% x 12 %

=7.2% (Dividend Growth)

Simple Dividend Growth Formula

Simple dividend growth formula is used to calculate the simple growth (not compounded). There are some other growth like Gordon dividend growth and compounded dividend growth, those growth are calculated by other formulas.

Simple Dividend Growth Formula =   Current Dividend     - 1  x 100                                                                Last Dividend

Dividend Free Cash flow Ratio

Dividend free cash flow is important consideration for dividend decision. This formula explains about a link between company cash flow and its dividend.

Dividend free cash Flow Ratio =       Dividend for Year                                                                  Free Cash flow

Example

Company ABS has paid following dividend from 2001 to 2005.

Year              Earnings                      Dividend                Free cash Flow

2001             100                             20 million                40 million

2002             100                             40 million                80 million

2003             100                             30 million                60 million

Solution

Year                    Dividend                 Free cash Flow       Dividend /Free cash Flow

2001                   20 million                40 million                20/40 =50%

2002                   40 million                80 million                40/80 = 50%

2003                   30 million                60 million                30/60 = 50%

Absorption Rate Formulas

Absorption Rate Formulas

Absorption rate are used to absorb the production overheads. There are number of absorption rates used by the companies. In this article we have given the formulas of some important absorption rates.

Machine Absorption Rate Formula

Machine Absorption rate is calculated by dividing production overhead by the budgeted machine Hrs.

Machine Absorption Rate Formula =   Estimated Production Overhead    x 100                                                                        Budgeted Machine Hrs

 Labour Absorption Rate Formula

Labour absorption rate is calculated by dividing the estimated production overheads by the budgeted machine hours.

Labour Hour Absorption Rate Formula =   Estimated Production Overhead  x 100                                                                         Budgeted Labour Hrs

Product Absorption Rate Formula

Product absorption rate may be calculated by dividing estimated production overheads by budgeted units is to be produced.

Product Absorption Rate Formula =   Estimated Production Overhead    x 100                                                                 Budgeted Production (units)

Over Absorption Formula

Over absorption formula result in, when absorbed overhead (using predetermined absorption rate) are more than actual overheads.

Over Absorption = Absorbed overhead > Actual Overheads

Under Absorption Formula

Under absorption results, when absorbed overhead are less than the actual overheads. It is to be noted that overhead are absorbed with help of predetermined absorption rate.

under Absorption = Absorbed overhead < Actual Overheads

Provision Formulas

Provision Formulas

Provision is created for a current liability, which would be confirmed in future. The provision is recognized on the best estimates. Provision is calculated as percentage of some relevant factor i.e. (sales, accounting Profit).  Some famous provisions are;

1.   Provision for warranty

2.   Provision for Tax

3.   Provision for Doubtful Debt

Formulas of these provisions have been given below. These formulas have been explained in more details with examples in my other articles.

Provision for Warranty Formula

Provision for Warranty  = % of Warranty x Sales

Provision for Warranty Formula Example

Sales (Year 2001) = 200,000

Warranty Required = 10% of Sales

How much provision is required?

Solution

Warranty = % of Warranty x Sales

= 10% x 200,000

=20,000 (Provision for warranty)

Provision for Tax Formula

Provision for Tax =Tax Rate x Accounting Profit

Provision for Tax Formula Example

Profit before Tax = 250,000

Tax rate = 30%

What would be the provision for tax?

Solution

Provision for tax =Tax Rate x Accounting Profit

= 250,000 x 30%

=75,000 (Provision for tax)

Provision for Doubtful Debt Formula

Provision for Doubtful Debt = % of Doubtful Debt x Account Receivable

Provision for Doubtful Debt Formula Example

Account Receivable Closing balance = 100,000

Allowance for doubtful Debt = 10%

Calculate allowance for Doubtful debt?

Solution

% of Allowance for Doubtful Debt x Account Receivable

=10% x 100,000

=10,000 (Allowance for Doubtful Debt)