Working capital

management
• Working capital
policies
• Management of Short-
term assets and
liabilities
 Expected Learning outcomes
1. Understand the concept of working capital management.
2. Know the importance of working capital management.
3. Identify and understand the factors affecting the firm's working capital
policy.
4. Appreciate the need of knowing how to trace cash movement through the
firm's operation.
5. Understand and calculate the operating cycle and cash conversion cycle of
a business firm.
6. Know how operating cycle can be shortened.
7. Distinguish the alternative policies as to the amount of investment in
current assets.
8. Identify and distinguish between the costs relevant to investment in current
assets i.e. carrying costs versus shortage costs
9. Know the alternative policies in financing investment in current assets.
 Working Capital

-Is current assets less current liabilities.

- Also called as “NET CURRENT ASSETS”.
- Excludes non-current assets.
 Working Capital
Management
The process of overseeing and controlling
a company's short-term assets and
liabilities to ensure efficiency and enough
liquidity to meet day-to-day expenses.
WCM oversees and improves a company's
money, inventory, and short-term debt.
reasons why wcm is important
1. It compromises a large portion of the firm's total assets.

2. The financial manager has considerable responsibility and control

in managing the level of current assets and current liabilities.

3. WCM directly affects the firm's long-term growth and survival

because higher levels of current assets are needed to support
production and sales growth.

4. Liquidity and profitability are likewise directly affected by WCM.

 factors affecting the firm's
working capital policy
1. The Nature of Operations. Working capital requirements differ gently among
manufacturing, retailing, and other services organizations.
Ex. Retailing firms have a high proportion of total assets in ccurrent category because they
earn their return form their current assets such as inventory.

2. The Volume of Sales. More currents assets such as accounte receivable, inventories,
are needed to support a higher level of sales.

3. The Variation of Cash Flows. The greater the fluctuations of the firm's cash inflows
and outflows, the greater the level of net income required.

4. The Operating Cycle Period. The length of time cash tied up in a firm operating
process.

Ex. The operating cycle of a manufacturing firm is the length of time required to purchase raw
materials on credit, produce and sell a product, collect the sales receipt and repay the credit.
Shortening the operating cycle reduces the amount of time funds are tied up in working
capital, thus lower the levels of working capital required.
 Tracing cash and networking
capital
To trace cash movement through firm's operation, we must measure the
operating cycle as well as cash conversion cycle. Understanding the
following time periods is necessary in monitoring the working capital
movement.

1. Operating Cycle. The length of time in which the firm purchases or

produce inventory sell it and receive cash.

2. Cash Conversion Cycle. The length of time funds are tied up in working
capital or the length of between your paying your working capital and
collecting cash from the sale of inventory.

• Inventory Conversion Period. The average time to purchase merchandise

or to purchase raw materials and convert them to finished goods and
sell them.
• Average Collection Period. The average length of time required to
convert the firm's receivable into cash, that is, to collect cash following a
sale.
• Payables Deferral Period. The average length of time between the
purchase of materials and labor or merchandise and the payment of cash
for them.
OPERATING AND CASH CONVERSION
CYCLE ILLUSTRATION
 the Operating Cycle
The operating cycle of a company consists of the time period
between the procurement of inventory of raw materials and
turns them into finished goods.
FORMULA:
 The cash conversion cycle
The firm's cash conversion cycle is determine by subtracting
the average payment period from the operating cycle.

FORMULA:
 The cash conversion cycle
The Cash Conversion Cycle may be calculated as follows:
FORMULA:
 How can operating cycle be reduce
The aim of every management is to reduce the length of cycle or the number of
operating cycles in a year in order to reduce the need for working capital.

The following could be the reasons for longer cycling period:

1. Defective purchasing policy and practices that could lead to
• Purchase of raw materials or merchandise in excess/short of requirements
• Buying inferior, defective materials thus lengthening the production time
•Failure to get credit from suppliers
•Failure to get trade/cash discount and;
•Inability to purchase goods due to seasonal swings

2. Lack of proper production planning, coordination and control that could

results to protracted maunfacturing cycle.
3. Defective inventory policy
4. Use of outdated machinery, technology as well, poor maintenance and upkeep
of plant, equipment, and infrastracture facilities.
 How can operating cycle be reduce
5. Defective credit policy and receivable collections period.

6. Lack of proper monitoring of external environment.

Remedies that may be adopted to reduce the length of operating cycle

period are as follows:
1. Production Management

2. Purchasing Management

3. Marketing Management
4. Credit and Collection Policies

5. External Environment
Alternative policies as to the
size of investment in current
assets
Three alternative policies regarding the total amount of
current assets carried:

1. Relaxed Current Asset Inventory Policy

This policy relatively large amounts of cash, marketable

securities, and inventories are carried and under which
sales are stimulated by granting liberal terms resulting in a
high level of receivables. In this policy, marginal carrying
costs of current assets will increase while marginal
shortage cost will decrease.
Alternative policies as to the size
of investment in current assets
2. Restricted Current Assets Investment Policy

This is a policy under which holdings of cash, securities,

invemtories, and receivables are minimized. Marginal
carrying costs of current assets will decrease while
marginal shortage costs will increase.

3. Moderate Current Assets Investment Policy

This is a policy that between relaxed and restricted

policies. This policy dictates that the firm will just have
enough current assets so that the marginal carrying costs
and marginal shortage costs are equal, thereby minimizing
total cost.
Cost relevant to investment in
current assets
1. Carrying cost
costs asscociated with having current assets. It consists of
opportunity costs associated with having capital tied up in
current assets instead of more productive fixed assets and
explicit costs which are costs necessary to maintain the
value of the current assets.

2. Shortage Cost

costs associated not having current assets and can include

opportunity costs such as sales lost due to not having
inventory on hand and explicit transaction fees paid to
replenish the particular type of current assets.
 alternative strategies in
financing working capital
Effective working capital management requires a set of strategies to
manage the level, composition and finance of a firm's current assets.
Decision should be based on the simultaneous analysis of their joint
impact of return and risks.
In addition, consideration should be given on the broad categories of assets.
These are:
1. Long Term/ Permanent Assets
Consist of property, plant, and equipment, long-term invesment and
and the portion of the firm's current assets that remain unchanged
over the year.
2. Fluctuating or Seasonal Assets.
Current assets that vary over the year due to seasonal or cyclical
needs.
 policies for financing current
assets
Policy I: FLEXIBLE FINANCING POLICY
Involves the decision to financethe peaks of asset requirement with
long-term debt and equity. It provides the firm with a large
investment surplus in cash and marketable securities cost of the
time.

Policy II: RESTRICTED FINANCING COMPANY

Involves a decision to finance the valley ot troughs of assets with

long-term debt and equity but will have to seek short-term
financing to all peak demand fluctuation for current assets as well
as for in between demand situations. This policy is the most
conservative but the least convenient because it involve seeking
short-term almost all of the time.
 policies for financing current
assets
Policy III: COMPROMISE FINANCING POLICY

Involves the firm financing the seasonally adjusted average level of

asset demand with long-term debt and equity. It uses short-term
financing and short-term investment as needed.

However, the ff. should bw considered in analyzing in

advantages/disadvantages of the alternative financing policy for
the working capital:
•Maturity Hedging
• Cash Reserves
• Relative Interest Rates
• Availability and Costs of Alternative Financing
• Impact on Future Sales
thank you