LEARNING OBJECTIVES

• At the end of this chapter, you should be able to:

1. Define working capital management terminology.
2. Understand classification of assets and sources of financing.
3. Calculate on Cash Conversion Cycle (CCC).
WORKING CAPITAL MANAGEMENT

Managing the firm’s working capital, which is managing it current assets and
current liabilities
The objective of a firm in the working capital management should be to
maximize shareholder wealth, avoid decisions that give negative net present
value and seeking positive net present values.
 WORKING CAPITAL TERMINOLOGY

1. Working capital , sometimes called gross working capital, simply refers to current
assets
2. Net working capital is defined as current assets minus current liabilities.
3. Working capital management involves the management of current assets and current
liabilities of company.

Working Capital-Introduction 4
Types of Assets
 Asset Explanation
1) Permanent Permanent assets can classified into two:
a. Permanent Current Assets
Refers to the amount of current assets on hand at its lowest level
in a year. This includes the firm’s minimum cash or bank balance
and the minimum level of inventories maintained by the firm over
the year.
b. Non-current Assets
Refers to the assets which can be held for more than one year
such as building, machinery and land.

2) Temporary Current assets that will be liquidated and replace within a year such as
cash, prepaid expenses, debtors, marketable securities, account
receivable and inventories.
Types Sources of Financing
 Financing Explanation
1) Permanent It is a source of financing with a maturity period of more than one year
such as medium-term loans, long-term loans, bonds, common stocks
and preferred stocks.

2) Temporary It is a source of financing with a maturity period within one year

comprising current liabilities such as creditors, bank overdraft, treasury
bills, short-term loan, and commercial paper.

3) Spontaneous It is a source of financing which used by day to day operation that

consists of account payable and accrued expenses.
 Working Capital Policies

1. Hedging
2. Conservative
3. Aggressive
 Hedging Approach
This approach also known as matching approach, moderate approach and
self-liquidity approach.
Temporary current assets is equal to temporary sources of financing.
Whereas, the amount of permanent assets is equal to permanent sources of
financing.
 All permanent assets are financed by permanent and spontaneous sources
of financing while the temporary current asset are financed by temporary
and spontaneous sources of financing.
The risk and return is moderate.
Hedging Approach
 Conservative Approach
The amount of temporary current assets is more than temporary
sources of financing. Whereas, the amount of permanent assets is less
than permanent sources of financing.
In this approach, all permanent assets and part of temporary current
assets are financed by permanent and spontaneous source of financing
while the other part of temporary current assets are financed by
temporary and spontaneous source of financing.
The risk and return is lower.
Conservative Approach
 Aggressive Approach
The amount of temporary current assets is less than temporary
sources of financing. Whereas, the amount of permanent assets is
more than permanent sources of financing.
All temporary current assets and part of permanent assets are
financed by temporary and spontaneous sources of financing while
the other part of permanent assets are financed by permanent and
spontaneous sources of financing.
The risk and return is higher.
Aggressive Approach
Illustration 1
Gamuda Bhd‘ s summarized Statement of Financial Position as follows
Assets RM
Non-current assets 100,000 P
Inventories 50,000 T
Account receivable 30,000 T
Cash 20,000 T
200,000
Liabilities & Equity
Equity 80,000
Non-current liabilities 60,000
Current liabilities 50,000
Accruals 10,000
200,000
Calculate:
a. Permanent assets.
b. Temporary assets.
c. Permanent sources of financing.
d. Temporary sources of financing.
e. Spontaneous sources of financing.

Solution:
a. Permanent assets = RM100,000

b. Temporary assets = RM50,000 + RM30,000 + RM20,000

= RM100,000

c. Permanent sources of financing = RM80,000 + RM60,000

= RM140,000

d. Temporary sources of financing = RM50,000

e. Spontaneous sources of financing = RM10,000

Illustration 2
The following is the statement of financial position for both companies:
Izz Berhad Ozzil Berhad
(RM) (RM)
Net non-current assets 1,000 1,250
Current assets 240 180
1,240 1,430

Common equity 830 1,030

Long-term liabilities 200 250
Current liabilities 210 150
1,240 1,430

Note: 20% of current assets are permanent.

a. How much of the permanent assets and temporary assets for both companies?
b. How much of the temporary financing and permanent financing for both companies?

Solution:
a. Izz Berhad
Permanent Assets = RM1,000 + (0.2 x 240) = RM1,048
Temporary Assets = RM240 x 0.8 = RM192

Ozzil Berhad
Permanent Assets = RM1,250 + (0.2 x 180) = RM1,286
Temporary Assets = RM180 x 0.8 = RM144

b. Izz Berhad
Permanent Financing = RM830 + RM200 = RM1,030
Temporary Financing = RM210

Ozzil Berhad
Permanent Financing = RM1,030 + RM250 = RM1,280
Temporary Financing = RM150
Cash Conversion Cycle model
 Cash Conversion Cycle (CCC)
Cash Conversion Cycle (CCC)
The length of time from the beginning of production until the cash collected from the sales
of product minus the average length of payment period.
CCC = ICP + ACP – PDP
Where;
ICP = Inventory Conversion Period
ACP = Average Collection Period
PDP = Payable Deferral Period
Operating Cycle (OC)
The length of time from the beginning of production until the cash collected from the sales
of product.
OC = ICP + ACP
Inventory Conversion Period (ICP)
Average length of time required to convert from raw materials into finished good and sell
them.
ICP = Inventory
COGS / 360
@
ICP = Inventory
Sales / 360
Where;
COGS = Cost of goods sold
Average Collection Period (ACP)
Average length of time required to collect the firm’s credit sales.
ACP = Account Receivable
Credit Sales / 360

Payable Deferral Period

Average length of time required between the purchases of raw material until payment have
been made.
PDP = Account Payable
COGS / 360
Where;
COGS = Cost of goods sold
 Ways to reduce Cash Conversion Cycle

Reduce the inventory by making sales quickly.

Collect cash form account receivable faster.
Make payment slowly, but not yet give impact on credit rating.
Manage mail, processing and clearing time when making the
payment.
Illustration 3
Bennawan Bhd shows statement as follows:
Cash and marketable securities RM70,000
Account receivable RM80,000
Inventories RM70,000
Total Current Assets RM220,000

Account payable RM65,000

Bank loan RM75,000
Accruals RM20,000
Total Current Liabilities RM160,000

Sales for the firm are RM800,000 and cost of goods sold is 50% from its sales. Payable deferral
period for the firm is 50 days. The firm has a current annual outlay of RM150,000 on one cycle
investment. The firm also pays 9% for its negotiated financing. Assumes that 360-days a year.

Calculate:
a. Operating cycle.
b. Cash conversion cycle.
c. Firm’s annual saving if the operating cycle is reduced by 10 days.

Solution:
a. Operating cycle
ICP = RM70,000 = 63 days
(50% x RM800,000) / 360

ACP = RM80,000 = 36 days

RM800,000 / 360
 OC = ICP + RCP
= 63 days + 36 days
= 99 days

a. Cash conversion cycle

CCC = OC – PDP
= 99 days – 50 days
= 49 days

b. Firm’s annual saving by reducing 10 days

Daily expenditure = RM150,000
360 days
= RM416.67

Firm’s annual saving by reducing 10 days = RM416.67 x 10 days x 9%

= RM375
OC = ICP + RCP
= 63 days + 36 days
= 99 days

Cash conversion cycle

CCC = OC – PDP
= 99 days – 50 days
= 49 days

Firm’s annual saving by reducing 10 days

Daily expenditure = RM150,000
360 days
= RM416.67

Firm’s annual saving by reducing 10 days = RM416.67 x 10 days x 9%

= RM375
 CONCLUSION
 In managing a firm’s working capital, the financial manager need to understand the risk and
trade – off that related to the trade-off that exists between a firm’s liquidity and profitability.

 There are three working capital financing policies

1. Hedging approach, where assets are matched with liabilities.
2. Conservative approach, where non-current assets and part of current assets are financed by
long-term funds.
3. Aggressive approach, short-term funds are used to a higher degree in financing current and
even non-current assets.

 The financial manager also need to know to compute the cash conversion cycle, which
represents the length of time on cash cycle. The shorter the cycle the better the management of
working capital.
 REFERENCE
• Arwa Mohammad, Ahmad Hadi Ibrahim, Izyani Hasbullah, Nor Asilah
Amin, Nurhidayatul Asyikin Ramlan, Nur Azlina Abdullah, Nurul Fazlin Ab
Mutalib, Siti Zuraidah Zainal, Wan Hereezuan Wan Ab Rahim, (2018)
Financial Manangement, Kolej Poly-Tech MARA Sdn Bhd.