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Measurement of  length of holding period for stocks and receivables explained

Measurement of length of holding period for stocks and receivables explained


(This article explains how to calculate holding period for raw materials,how to calculate holding period for work in process (semi-finished goods, how to calculate holding period for finished goods, how to calculate holding period for debt collection period).

In simple term, operating cycle means the length of time required to convert   ‘Non-Cash current assets’ like raw material, work in process, finished goods and receivables (book debts)] into cash. At each stage of operating cycle, i.e. stock of raw material, work-in-process, finished goods a manufacturing unit needs to hold the stock for a length of time in the workplace before dispatching the final products to the customers. The holding period of receivables is dependent on the period of credit extended to the customers. The tendency of some manufacturing units holding the current assets (stocks and receivables) beyond the requirement of holding period has the financial implication, as more amount of interest payable on current liabilities for the time taken in converting the current assets into cash.

The bankers who appraise the working capital limits shall decide the working capital on the basis of maximum operating cycle tenure. Normally the length of operating period is measured by months. The length of holding period is also calculated in days multiply by 360 in place of 12. The computation of holding period taken for holding raw materials, work-in-process, finished goods and the collection of receivables is of great interest in evaluating the working capital limit. Let us study here how the length of operating period is computed.

Calculation of holding period for raw material (RM):

Holding period of raw material (RM) in months is measured by the Average stock of RM divided by RM consumption multiplied by twelve.          [Holding period of raw material (RM) in months = Average stock of RM ×12 / RM consumption]                                                                                     The Average stock of RM is measured by opening balance of RM plus Closing stock of RM divided by 2 (two).

The raw material consumption is measured by opening stock of RM plus Purchase of RM minus closing stock of RM.

The holding period of Raw-materials is mainly dependent on the lead time involved in the procurement and quantity required to ensure uninterrupted production.

Calculation of holding period for work in Process (WIP):

Holding period of work in Process (WIP) in months is measured by Average stock of WIP divided by cost of production (COP) multiplied by 12 [Holding period of WIP in months = Average stock of WIP×12/ cost of production]

Average stock of WIP is measured by opening balance of WIP plus Closing stock of WIP divided by 2 (two). [Average stock of WIP= opening balance of WIP+ Closing stock of WIP/ 2 (two)].

The cost of production (COP) is measured by Raw materials consumed plus manufacturing expenses plus Depreciation, plus opening stock of work in process minus closing stock of work in process. [Cost of production (COP) = Raw materials consumed + manufacturing expenses + Depreciation, + opening stock of work in process – closing stock of work in process.]

The holding period of work-in-progress is dependent on the length of production cycle i.e. from the time Raw-materials are issued and till the finished goods are ready for dispatch.

Calculation of holding period for Finished Goods:

The Holding period of Finished Goods (FG) in months is measured by Average stock of FG multiplied by twelve and divided by cost of sales (COS)  [Holding period of Finished Goods (FG) in months = Average stock of FG×12/ Cost of sales

Average stock of FG is measured by opening balance of FG plus Closing stock of FG divided by 2 (two). [Average stock of FG = opening balance of FG+ Closing stock of FG / 2 (two).

Cost of sales (COS) is measured by Cost of Production (COP) plus Opening stock of finished goods minus Closing stock of finished goods.[Cost of sales (COS)= Cost of Production (COP)+ Opening stock of finished goods- Closing stock of finished goods.

The holding period of finished goods is dependent on the length of sales cycle i.e. the period of finished goods to be kept in the ware-house before sales.

Calculation of Debt collection Period:

Debt collection Period in months is measured by Average Receivables Outstanding multiplied by twelve and divided by Gross Credit Sales.      [Debt collection Period in months= Average Receivables Outstanding×12/Gross Credit Sales]

Average receivable outstanding is found out by adding sundry debtors, bills receivables (inland) and bills purchased and discounted by the bank (inland). In a similar manner, debt collection period calculated for inland bills, the debt collection period for export receivables is calculated.

Related articles (Category: Financial Analysis)

  1. Things to know before starting appraisal of working capital limits.
  2. Computation of working capital limits under Turn-Over method (Nayak Committee Norms)
  3. MPBF/Cash Budget methods of working capital appraisal
  4. Ratio analysis: learn the techniques & get into saddle

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