What are the methods for forecasting working capital requirements?

Methods for forecasting working capital requirements include the operating cycle method, budgetary control, and ratio analysis.

The operating cycle method is a popular approach for forecasting working capital requirements. This method involves calculating the length of the operating cycle, which is the time taken from the purchase of raw materials to the collection of sales revenue. The longer the operating cycle, the more working capital a business will need. This method is particularly useful for manufacturing businesses, where the operating cycle can be clearly defined.

Budgetary control is another method used to forecast working capital requirements. This involves preparing detailed budgets for all areas of the business, including sales, production, and overheads. These budgets are then used to estimate the amount of working capital needed to support the planned level of activity. This method requires a high level of detail and accuracy in budget preparation, but can provide a comprehensive view of the business's working capital needs.

Ratio analysis is a further method used to forecast working capital requirements. This involves analysing the business's financial ratios, such as the current ratio (current assets divided by current liabilities) and the quick ratio (quick assets divided by current liabilities). These ratios provide an indication of the business's liquidity and its ability to meet short-term obligations. By comparing these ratios with industry benchmarks, a business can estimate its working capital requirements.

Each of these methods has its strengths and weaknesses, and the choice of method will depend on the nature of the business and the accuracy of the information available. In practice, businesses often use a combination of these methods to forecast their working capital requirements.