Skip to main content

What is Working Capital Leverage (WCL)?


Working capital leverage: It shows the sensitivity of the return on investment with change in current assets. As we all know the working capital is difference between current assets and current liabilities. And the working capital is use for meeting day to day capital requirements in business operations. With the help of working capital leverage we will find out how productivity or profitability of a business is affected by change in current assets.

Formula:
Working Capital Leverage (WCL) = % ∆ROE / % ∆CA
Or
If % decreases in current assets:
WCL= CA / TA - ∆CA
If % increases in current assets:
WCL = CA / TA + ∆CA
Where,
CA = current assets
TA = total assets
ROE = return of capital employed or return on investment
∆CA = change in current assets

Example: Company A total assets are Rs. 17, 60, 800 and the current assets are Rs. 6, 00,000. The fixed assets are Rs. 11, 60, 800. Find out the working capital leverage if the current asset increases by 15%. The rate of return is 32%.

Solution: WCL= CA / TA - ∆CA
= 6, 00, 000 / 17, 60, 800 – 0.15*6, 00, 000
= 6, 00, 000 / 17, 60, 800 – 90, 000
= 6, 00, 000 / 16, 70, 000
= 0.35
Or  
= 35%
The % change in rate on capital employed is 35% which shows that if the current assets are decreases then there is inverse effect on rate on capital employed.

Example: The current asset of P Company is Rs. 1, 70, 600 and the rate of return is 26%. The net assets are Rs. 8, 05,600. 10% increase in current assets. Find out the % change in rate of return with change in current assets.

Solution: WCL= CA / TA + ∆CA
= 1, 70, 600 / 8, 05, 600 + 0.1*1, 70, 600
= 1, 70, 600 / 8, 05, 600 + 17, 060
 = 1, 70, 600 / 8, 22, 660
= 20%
The WCL of Company P is 20%. It shows that if the current assets increases then rate of return decreases. Or there is an inverse relationship between rate of return and current assets.

Example: Find out the working capital leverage of Company ABC, PQR and LMN. The total assets of Company LMN are Rs. 7, 62, 950. The total assets of Company ABC are Rs. 8, 12, 230. The current assets of Company LMN, ABC and PQR are Rs. 1, 02, 300, Rs. 2, 90, 000 and Rs. 80, 900 respectively. The total assets of company PQR is Rs.4, 10, 000. The rate of return of 3 Companies ABC, PQR and LMN are 37%, 12% and 10%. If 18% decrease in current assets find out which company shows higher effect of change in current assets on return on investment.

Solution: WCL= CA / TA - ∆CA
Company ABC:
= 2, 90, 000 / 8, 12, 230 - 0.18* 2, 90, 000
= 2, 90, 000 / 8, 12, 230 - 52, 200
= 2, 90, 000 / 7, 60, 030
= 0.38 or 38%
Company PQR:
= 80, 900 / 4, 10, 000 – 0.18*80, 900
= 80, 900 / 4, 10, 000 – 14, 562
=80, 900 / 3, 95, 438
= 0.20 or 20%
Company LMN:
= 1, 02, 300 / 7, 62, 950 – 0.18*1, 02, 300
= 1, 02, 300 / 7, 62, 950 – 18, 414
=1, 02, 300 / 7, 44, 536
= 13%
Company PQR shows higher % change in rate return with change in current assets from 12% to 20% in comparison to Company ABC and LMN.









Comments

  1. Rakshit ShettyDecember 21, 2024 3:23 pm

    Thanks for sharing useful Information with me and it's very helpful.I learned With the help of working capital leverage we will find out how productivity or profitability of a business is affected by change in current assets. Being Best CA coaching Centre in bangalore One of the Leading Coaching Centres in bangalore for Chartered Accountancy.

    ReplyDelete
  2. Chandrasekaran marimuthuDecember 21, 2024 4:33 pm

    Thanks for sharing useful Information. i Learned the help of working capital leverage we will find out how productivity or profitability of a business is affected by change in current assets. Being Best CA coaching Centre in Coimbatore One of the Leading Coaching Centres in Coimbatore for Chartered Accountancy.

    ReplyDelete

Post a Comment

Popular posts from this blog

How to calculate Cost of Preference Share Capital?

Cost of Preference Share Capital:  An amount paid by company as dividend to preference shareholder is known as Cost of Preference Share Capital. Preference share is a small unit of a company’s capital which bears fixed rate of dividend and holder of it gets dividend when company earn profit. Dividend payable is not a tax deductible amount. So, there is no tax adjustments required for comparing with cost of debt. Formula for Cost of Preference Share: Irredeemable Preference Share Redeemable Preference Share K p  = Dp/NP K p  = D p +((RV-NP)/n )/ (RV+NP)/2 Where, K p  = Cost of Preference Share D p  = Dividend on preference share NP = Net proceeds from issue of preference share (Issue price – Flotation cost) RV = Redemption Value N = Period of preference share Example:  A company issues 20,000 irredeemable preference share at 8% whose face value is Rs.50 each at 4% discount. Find out the Cost of ...
89 comments
Read more

What is the difference between Cheque book and Pass book?

 Cheque book is issued by bank in customers / account holder request. With the help of this book account holder can withdraw cash from his/her account. Bank does not charge any fee to issued cheque book to its customer. But afterward bank charges some amount for using bank facility like cheque book, Debit card etc.So, Automatic some definite amount deducted from customer bank account. Pass book is  also issued by bank to its customer. It helps to record all the bank related activity according to date that is withdrawal and deposit. It is recorded by bank but the book is kept by customer to know the current balance of  his /her account.  Point of difference Pass book Cheque book What is the meaning of pass book and cheque book? Passbook is a book in which all withdrawal and deposit against customer account is recorded.   Cheque book is a book of cheques which are used to withdrawal the money to b...
Post a Comment
Read more

Numericals with solutions of Net income Approach

Net income approach questions and answers:   Questions:  Find out the value of the firm with the help of given information: Particulars Amount Earnings before interest and tax 3, 50, 000 Cost of equity 10% Cost of debt 7.2% Debenture 1,00,000 Find out the overall cost of capital with the help of net income approach. (Assume tax rate-10%) Solution: Particulars Amount Earnings before interest and tax 3, 50, 000 Less: Interest @7.2% 7, 200 Earnings before tax 3, 42, 800 Less: Tax@10% 34, 280 Net income 3, 08, 520 Cost of equity 10% Market value of equity (S =net income/ cost of equity) 30, 85, 200 Market value of debt (B) 1, 00, 000 Value of the firm (S+B) 31, 85, 200 Questions:  Find out the overall cost of capital if the equity capitalisation rate is 12...
Post a Comment
Read more