2. Definition
Working capital management refers to a company's
managerial accounting strategy designed to monitor and
utilize the two components of working capital, current
assets and current liabilities, to ensure the most financially
efficient operation of the company.
The primary purpose of working capital management is to
make sure the company always maintains sufficient cash
flow to meet its short-term operating costs and short-
term debt obligations.
3. Working capital management:
Includes both establishing working capital policy
which shows the level of each current asset and then
the day-to-day control of:
Cash
Inventories
Receivables
Short-term liabilities
4. TYPES OF WORKING CAPITAL
WORKING CAPITAL
BASIS OF
CONCEPT
BASIS OF
TIME
Gross
Working
Capital
Net
Working
Capital
Permanent
/ Fixed
WC
Temporary
/ Variable
WC
5. Concepts of Working Capital
Gross working capital (GWC)
GWC refers to the firm’s total investment in current
assets.
Current assets are the assets which can be converted
into cash within an accounting year (or operating cycle)
and include cash, short-term securities, debtors,
(accounts receivable or book debts) bills receivable and
stock (inventory).
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6. Concepts of Working Capital
Net working capital (NWC)
NWC refers to the difference between current
assets and current liabilities.
Current liabilities (CL) are those claims of outsiders
which are expected to mature for payment within
an accounting year and include creditors (accounts
payable), bills payable, and outstanding expenses.
NWC can be positive or negative.
Positive NWC = CA > CL
Negative NWC = CA < CL
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7. Operating Cycle
Operating cycle is the time duration required to convert sales,
after the conversion of resources into inventories, into cash.
The operating cycle of a manufacturing company involves three
phases:
Acquisition of resources such as raw material, labour, power and fuel
etc.
Manufacture of the product which includes conversion of raw material
into work-in-progress into finished goods.
Sale of the product either for cash or on credit. Credit sales create
account receivable for collection.
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8. Cont…
The length of the operating cycle of a manufacturing
firm is the sum of:
Inventory conversion period (ICP).
Debtors (receivable) conversion period (DCP).
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Operating cycle of a manufacturing firm
9. Gross Operating Cycle (GOC)
The firm’s gross operating cycle (GOC) can be
determined as inventory conversion period (ICP) plus
debtors conversion period (DCP). Thus, GOC is given
as follows:
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10. Inventory conversion period
Inventory conversion period is the total time
needed for producing and selling the product.
Typically, it includes:
raw material conversion period (RMCP)
work-in-process conversion period (WIPCP)
finished goods conversion period (FGCP)
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11. Net Operating Cycle
Net operating cycle (NOC) is the difference between gross
operating cycle and payables deferral period.
Net operating cycle is also referred to as cash conversion cycle.
The cash conversion cycle (CCC) is a metric that measures how
long it takes a company (in days) to transform its stock and other
resources into sales cash flows.
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12. The cash conversion cycle focuses on the time between
payments made for materials and labor and payments
received from sales:
Cash Inventory Receivables Payables
conversion = conversion + collection - deferral .
cycle period period period
ccc for Marchandising = Inventory Holding period +
Average Collection period- Average payables period
Cash Conversion Cycle
13. CASH CONVERSION CYCLE =
(Inventory Period + Receivables Period) – Accounts Payable Period
CASH CONVERSION CYCLE :
Period between firm’s payment for materials and collection on its sales
Inventory Period = Average Inventory / [Cost of Goods Sold / 365]
Receivables Period = Average Accounts Receivables / [Sales / 365]
Payable Period = Average Payable / [Sales / 365]
14. Working Capital Trade-off
Carrying Costs:
Costs of maintaining Current Assets; including opportinity cost of capital.
Investment in CASH & RECEIVABLES may cause an interest loss and
Investment in INVENTORY has opportinity cost of capital; storage & insurance costs
Shortage Costs:
Costs incurred from shortages in Current Assets
Shortage in CASH may incur unnecassary transaction costs of selling marketable securities and
Shortage in RECEIVABLES may cause to lose customers because of credit sales’ restrictions
Shortage in INVENTORY may have shut down production & unable to to fill orders promptly
Carrying Costs encourage firm to hold current assets to a MINIMUM
Shortage Costs encourage firm to hold current assets to a MAXIMUM
It’s an art to find the LEVEL of CURRENT ASSETS
that minimizes the sum of
Carrying Costs & Shortage Costs
15. PERMANENT AND VARIABLE WORKING CAPITAL
Permanent or fixed working capital
A minimum level of current assets, which is
continuously required by a firm to carry on its
business operations, is referred to as permanent
or fixed working capital.
Fluctuating or variable working capital
The extra working capital needed to support the
changing production and sales activities of the
firm is referred to as fluctuating or variable
working capital.
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16. Permanent Working Capital
Permanent Working Capital
The amount of current assets required to meet a
The amount of current assets required to meet a
firm’s long-term minimum needs.
firm’s long-term minimum needs.
Permanent current assets
Permanent current assets
TIME
Amount
of
working
Capital
17. Temporary Working
Temporary Working
Capital
Capital
The amount of current assets that varies with
The amount of current assets that varies with
seasonal requirements.
seasonal requirements.
Permanent current assets
Permanent current assets
TIME
Amount
of
working
Capital
Temporary current assets
Temporary current assets
19. 19
Working Capital Financing Policies
Moderate: Match the maturity of the assets with the maturity of
the financing.
A method of financing where each asset would be offset with
A method of financing where each asset would be offset with
a financing instrument of the same approximate maturity.
a financing instrument of the same approximate maturity.
Aggressive: Use short-term financing to finance permanent
assets.
Firm increases risks associated with short-term borrowing by
Firm increases risks associated with short-term borrowing by
using a larger proportion of short term financing.
using a larger proportion of short term financing.
Conservative: Use permanent capital for permanent assets and
temporary assets.
Firm can reduce risks associated with short-term borrowing
Firm can reduce risks associated with short-term borrowing
by using a larger proportion of long-term financing.
by using a larger proportion of long-term financing.
21. Moderate or Hedging (or Maturity
Hedging (or Maturity
Matching) Approach
Matching) Approach
Fixed assets and the non-seasonal portion of current
assets are financed with long-term debt and equity
(long-term profitability of assets to cover the long-
term financing costs of the firm).
Seasonal needs are financed with short-term loans
(under normal operations sufficient cash flow is
expected to cover the short-term financing cost).
22. (Conservative Approach)
(Conservative Approach)
Firm can reduce risks associated with short-term borrowing by using a
Firm can reduce risks associated with short-term borrowing by using a
larger proportion of long-term financing.
larger proportion of long-term financing.
TIME
DOLLAR
AMOUNT
Long-term financing
Fixed assets
Fixed assets
Current assets
Current assets
Short-term Investment
Short-term Investment
Short Term Financing
24. Firm increases risks associated with short-term borrowing by using a larger
Firm increases risks associated with short-term borrowing by using a larger
proportion of short-term financing.
proportion of short-term financing.
TIME
DOLLAR
AMOUNT
Long-term financing
Fixed assets
Fixed assets
Current assets
Current assets
Short-term financing
(Aggressive Approach)
(Aggressive Approach)
26. The choice of working capital policy is a
classic risk/return tradeoff.
The aggressive policy promises the highest
return but carries the greatest risk.
The conservative policy has the least risk
but also the lowest expected return.
The moderate (maturity matching) policy
falls between the two extremes.
27. Management of Cash
What Is Cash? Cash is legal tender—currency or coins—that
can be used to exchange goods, debt, or services.
Firms hold cash balances in checking accounts. Why?
1. Transaction motive: Firms maintain cash balances to conduct
normal business transactions. For example,
Payroll must be met
Supplies and inventory purchases must be paid
Trade discounts should be taken if financially attractive
Other day-to-day expenses of being in business must be met
28. Management of Cash a
2. Precautionary motive: Firms maintain cash
balances to meet precautionary liquidity needs.
3. Speculative motive: Firms maintain cash
balances in order to “speculate” – that is, to take
advantage of unanticipated business opportunities
that may come along from time to time.
29. Management of Cash
Improving Cash Flow
Actions firm may take to improve cash flow
pattern:
1. Attempt to synchronize cash inflows and cash
outflows
Common among large corporations
E.g. Firm bills customers on regular schedule throughout
month and also pays its own bills according to a regular
monthly schedule.
This enables firm to match cash receipts with cash
disbursements.
30. Management of Cash
Improving Cash Flow
2. Expedite check-clearing process, slow
disbursements of cash, and maximize use of “float”
in corporate checking accounts
Three developments in financial services industry have
changed nature of cash management process for
corporate treasurers
31. Accounts Receivable Management
Accounts Receivable (AR) is the proceeds or payment which the
company will receive from its customers who have purchased its
goods & services on credit.
Accounts receivable management requires balance between cost
of extending credit and benefit received from extending credit.
No universal optimization model to determine credit policy for
all firms since each firm has unique operating characteristics
that affect its credit policy.
However, there are numerous general techniques for credit
management.
32. Accounts Receivable Management
“Five Cs” of credit analysis” used to decide
whether or not to extend credit to particular customer:
1. Capacity: whether borrowing firm has financial capacity to meet
required account payments
2. Capital: general financial condition of firm as judged by analysis of
financial statements
3. Conditions: operating and financial condition of firm
4. Character: moral integrity of credit applicant and whether borrower
is likely to give his/her best efforts to honoring credit obligation
5. Collateral: existence of assets (i.e. inventory, accounts receivable)
that may be pledged by borrowing firm as security for credit
extended
33. Inventory Management
Cost of maintaining inventory:
1. Carrying costs: all costs associated with carrying
inventory
Storage, handling, loss in value due to obsolescence and physical
deterioration, taxes, insurance, financing
2. Ordering costs:
Cost of placing orders for new inventory (fixed cost: same dollar
amount regardless of quantity ordered)
Cost of shipping and receiving new inventory (variable cost:
increase with increases in quantity ordered)
34. Inventory Management
Total inventory maintenance costs (carrying
costs plus ordering costs) vary inversely.
Carrying costs increase with increases in average
inventory levels and therefore argue in favor of low
levels of inventory in order to hold these costs down.
Ordering costs decrease with increases in average
inventory levels and therefore firm wants to carry high
levels of inventory so that it does not have to reorder
inventory as often as it would if it carried low levels of
inventory.
![CASH CONVERSION CYCLE =
(Inventory Period + Receivables Period) – Accounts Payable Period
CASH CONVERSION CYCLE :
Period between firm’s payment for materials and collection on its sales
Inventory Period = Average Inventory / [Cost of Goods Sold / 365]
Receivables Period = Average Accounts Receivables / [Sales / 365]
Payable Period = Average Payable / [Sales / 365]](https://image.slidesharecdn.com/chapter4workingcapitalmanagement-250414114856-bc2238ad/85/Chapter-4-Working-capital-Management-ppt-13-320.jpg)
