This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
It was remarked at the beginning of this chapter that it would be impracticable to attempt to draw up any invariable formula for calculating the amount of working capital required in any given concern. We must content ourselves with the general statement that working capital requirements vary roughly in proportion to the volume of business, the length of period of manufacture, the average length of credit extended to customers, and the extent of seasonal variations in volume of business, and that they vary roughly in inverse proportion to the rapidity of turnover, length of credit obtained in purchases of goods, and the facilities available for converting current assets into cash. These are the factors to be taken into account.
Inasmuch as the customary unit of time used in reckoning most commercial operations is the month, it is worth while, in all close thinking and figuring as to the working capital requirements, to make estimates on a month-to-month basis. An estimate of this nature relating to a hypothetical case of a house doing an instalment business has already been given and will serve as an illustration of the method that should be followed in making up all such estimates. If all the factors that have just been named are known, and assuming in addition that the various costs of manufacture or of purchase, selling, overhead administration, and the like are known, there will be no difficulty in figuring out just what the cash outgo and cash receipts of each month will amount to. This will show the working capital requirements month by month. By adding a liberal margin to cover faulty estimates and contingencies, the approximate amount of working capital required, even for a new corporation, can be estimated. In the case of an established corporation, which has behind it years of experience and of records, the information that is desired can be worked out with greater accuracy.