CHAPTER 3
WORKING
CAPITAL
MANAGEMENT
Chapter 17
Addressing
Working Capital
Policies and
Management of
Short-term
Assets and
Liabilities
INTRODUCTION
Working Capital Management
Working capital management is a
business strategy that helps companies
monitor and use their current assets
and liabilities.
Working Capital Management is
associated with short-term financial
decision-making.
Reasons why Working Capital Management is Important
Working capital comprises a large portion of the firm’s total assets.
Altough the level of working capital varies widely among different
1 industries, firms in manufarturing and trading industries more often than
not, keep more than half of their assets in current assets.
The financial manager has considerable responsibility
2
and control in managing the level of current assets
and current liabilities.
Reasons why Working Capital Management is Important
Working capital management directly affects the firm’s long-
3 term growth and survival because higher levels of current
assets are needed to support production and sales growth.
Liquidity and profitability are likewise directly affected by
working capital management. Without sufficient liquidity, a firm
4 may be unable to pay its liabilities as they mature. The firm’s
profitability is also affected because current assets must be
financed and financing involves interest expenses.
Factors Affecting the Firm’s
Working Capital Policy
1. The Nature of Operations 2. The Volume of Sales
Working capital requirements More current assets such as
differ greatly among accounts receivables and
manufacturing, retailing and inventories, are needed to
service organizations. support a higher level of sales.
3. The Variation of Cash Flows 4. The Operating Cycle Period
The greater the fluctuations in The operating cycle is
the firm’s cash inflows and the length of time cash is
outflows, the greater the level tied up in a firm’s
09 of net working capital required. operating process.
TRACING CASH AND
net working capital
OPERATING
CYCLE
The length of time in which
the firm purchases or
produce inventory, sell it
and receive it.
CASH CONVERSION
CYCLE
The length of time funds are tied
up in working capital or the length
of time between paying for
working capital and collecting
cash from the sale of inventory.
CASH CONVERSION CYCLE
PERIODS:
INVENTORY AVERAGE PAYABLES
CONVERSION PERIOD COLLECTION PERIOD DEFERRAL PERIOD
The average time required The average length of The average length of
to purchase merchandise time required to time between the
or to purchase raw convert the firm’s purchase of materials
materials and convert receivables into cash, and labor or merchandise
them into finished goods that is, to collect cash and the payment of cash
and then sell them. following a sale. for them.
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 ( for
manufacturing concerns), sell them and receive payment
for them.
THE CASH CONVERSION CYCLE
The cash conversion cycle (CCC) is a metric that expresses
the length of time (in days) that it takes for a company to
convert its investments in inventory and other resources
into cash flows from sales.
CCC FORMULA
THE CCC MAY ALSO BE
CALCULATED AS
FOLLOWS:
HOW CAN OPERATING CYCLE BE REDUCED?
The aim of every management should be to reduce
the length of operating cycle in a year in order to
reduce the need for working captal.
HOW CAN
OPERATING CYCLE
BE REDUCED?
Remedies that may be adopted to reduce the length of
operating cycle period
Production Management Marketing Management
the production manager affects the sale and production
the length of operating cycle by policies should be
managing and controlling synchronized as far as
manufacturing cycle, which is possible.
part of operating cycle and
influences directly.
Purchasing Management Credit and Collection
Policies
the purchase manager owes a
responsibility in ensuring Sound credit and collection
availability of right type of policies enable the Finance
materials in right quantity of manager in minimizing
right quality at right price on investment in working capital
right time and at right place. in the form of book debts.
External Environment
the length of operating cycle is equally
influenced by external environment.
Abrupt changes in basic conditions would
affect the the length of operating cycle.
ALTERNATIVE POLICIES AS TO THE SIZE OF
INVESTMENT IN CURRENT ASSETS
Relaxed Current Asset Moderate Current Asset
Investment Policy Investment Policy
current asset estimation is done balance between the other
very aggressively. Implemented two policies.
without any tolerance of
deviation. Risk is lower than the
restricted and higher than
Saves interest cost due to lower conservative. Reasonable
working capital requirement. assurance of smooth
operations.
Restricted Current Asset
Investment Policy
Current asset estimation is done
after careful consideration of
various factors. Advantage of no or
low risk.
COST RELEVANT TO
INVESTMENT IN CURRENT
ASSETS
CARRYING COST
are associated with having assets such as
opportunity and explicit costs.
SHORTAGE COSTS
are associated with not having current
assets and include opportunity and
explicit costs.
ALTERNATIVE STRATEGIES IN FINANCING
WORK CAPITAL
LONG-TERM/ PERMANENT ASSETS
these consist of property, plant and equipment,
long term investment and portion of a firm’s
current assets.
FLUCTUATING OR SEASONAL ASSETS
these are the current assets that vary over the year
due to seasonal or cyclical needs.
WHICH FINANCING POLICY SHOULD BE CHOSEN?
THE PROS AND CONS IN ALTERNATIVE FINANCING
POLICY FOR WORKING CAPITAL
Maturity Hedging Availability and Cost of Alternative
Financing
Cash Reserves
Relatives Interest Rate Impact on Future Sales
QUESTIONS?
