Explain the concepts of percentage of sales method and regression analysis method in estimating working capital with the help of suitable examples.

Answer 6(b) Percentage of sales method: This method of estimating working capital requirements is based on the assumption that the level of working capital for any firm is directly related to its sales value. If past experience indicates stable relationship between the amount of sales and working capital then this basis may be used to determine the requirements of working capital for future. For example, if sales for the year 2020 amounted to ₹ 30,00,000 and working capital required was ₹ 6,00,000, the requirement of working capital for the year 2021 on an estimated sales of ₹ 40,00,000 will be ₹ 8,00,000 that is 20% of ₹ 40,00,000. The individual items of current assets and current liabilities can also be estimated on the basis of past experience as a percentage of sales. This method is simple to understand and easy to operate but it cannot be applied in all cases because the direct relationship between sales and working capital may not be established. Regression analysis method: This method of forecasting working capital requirements is based upon the statistical technique of estimating or predicting the unknown value of a dependent variable from the known value of an independent variable. It is the measure of the average relationship between two or more variables that is sales and working capital in terms of the original units of the data. The relationship between sales and working capital are presented by the equation: Y = a + bx Where y = working capital a = intercept of the least square b = slope of the regression line x = sales