A contractor is planning to establish a business and needs to determine working capital requirements. If monthly operating expenses are $45,000 and the average collection period for receivables is 75 days, what minimum working capital should be maintained?
Correct Answer
C) $112,500
Working capital should cover expenses during the collection period: $45,000 × (75 days ÷ 30 days) = $45,000 × 2.5 = $112,500. This ensures cash flow during the receivables collection cycle.
Why This Is the Correct Answer
Working capital must cover operating expenses during the entire receivables collection period to maintain cash flow. The calculation converts the 75-day collection period into months (75 ÷ 30 = 2.5 months) and multiplies by monthly expenses ($45,000 × 2.5 = $112,500). This ensures the business can pay its bills while waiting for customers to pay their invoices.
Why the Other Options Are Wrong
Option A: $150,000
This amount ($90,000) only covers 2 months of expenses ($45,000 × 2), which is insufficient for a 75-day (2.5 month) collection period.
Option D: $90,000
This amount ($135,000) covers 3 months of expenses, which exceeds the required 2.5-month collection period and represents unnecessary excess capital.
Memory Technique
Remember 'WCED': Working Capital = Expenses × Days. Convert days to months first (÷30), then multiply by monthly expenses.
Reference Hint
Business and Finance for Contractors - Chapter on Cash Flow Management and Working Capital Requirements
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