3. Methods of definition of demand for circulating assets
The effective usage of circulating assets in many respects depends upon the correct definition of the need in circulating assets. Understating the value of circulating assets entails instability of the financial position, faults in the production process and the decrease of manufacturing volumes and profit. Overstating the value of circulating assets reduces opportunities of the enterprise to make investments (capital expenditures) for production expansion.
The need for circulating assets depends on the set of factors: volumes of production and realization; the character of the enterprise activity; the duration of a production cycle; kinds and structure of consumed raw materials; rates of production volumes growth, etc.
Accurate calculation of the enterprise need in circulating assets should be carried out with taking into account the time of circulating assets stay in the sphere of production (manufacture) and the sphere of circulation.
The time of circulating assets stay in the sphere of production (manufacture) covers the period during which circulating assets stay in the state of stocks (resource) and as work-in-process.
The time of circulating assets stay in the sphere of circulation covers the period of their stay in the form of the residues of non-realized production, in the form of factory shipments which have not yet been paid, accounts receivable, in the form of cash assets (resources) in the enterprise cash department and on bank accounts.
The higher is the speed of a revolution (total time of stay in the sphere of production and in the sphere of circulation), the less is the need in circulating assets.
The enterprise is interested in the reduction of its circulating capital size. But this reduction should have reasonable limits, since circulating assets should provide the normal mode of the enterprise work.
When defining the optimum need in circulating assets the sum of cash assets is calculated, which will be advanced for creating industrial stocks, backlogs for work-in-process and accumulation of finished commodity in warehouses. For this purpose three methods are used: analytical one, coefficient one, and the direct account method.
The essence of the analytical method (or the experiment and statistical method) is as follows: when analyzing available inventory holdings their actual stock is corrected and excessive and unnecessary values are excluded.
When using the coefficient method the norm (standard) of the prior period undergoes amendments for the planned change of volumes of manufacturing and for the acceleration of the capital turnover.
Analytical and coefficient methods can be applied at those enterprises which function more than a year, have generated the production program and have organized the production process, have statistical data for the previous years and do not have sufficient amount of qualified experts for more detailed work in the field of planning circulating assets.
The method of the direct calculation provides the calculation of stocks for each element of circulating assets. This method is used when organizing new enterprise and periodic specifying of the need for circulating assets of the operating enterprise.
The general specifications (norms, standards) of owned circulating assets are defined as the extent of their minimal need for the formation of stocks of raw material, materials, fuel, work-in-process, deferrals, finished commodity.
The common norm (standard) of circulating assets consists of the sum of special norms:
Ncom = Nis + Nwip + Nfg + Nd ,
where Nis- the standard of industrial stocks; Nwip - the standard of work-in-process; Nfg - the standard of finished goods; Nd - the standard of deferrals.
The standard of industrial stocks depends on daily (day and night) average consumption of raw materials, materials, fuel and the norm of the stock in days:
Nis = Consd x Tdays ,
where Consd - daily (day and night) average consumption of the given kind of raw material or materials (in monetary units); Tdays - the norm of the stock in days.
The average norm of the stock in days is estimated in whole as the weighted average value of norms of the stock of circulating assets for separate kinds.
The norm of the stock in days for a separate kind of circulating assets consists of the following components:
Tdays = Ttrans + Tcur + Tins + Tseas ,
where Ttrans - the transport stock;Tcur - the current warehouse stock; Tins – the insurance (the guarantee stock); Tseas - the seasonal stock.
The transport stock is established according to the duration of the transit time of the cargo from the supplier to the consumer with taking into account the time of documents circulation.