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Subject Code: BFINMAX

Subject Title: Financial Management
Subject Description: This course provides an introduction to financial management and finance;
cash flows and financial analysis. Topics also include cash flows
estimation; operating and financial leverage; financial planning and
forecasting; managing working capital, cash and marketable securities
management and accounts receivable and inventory management.
No. of Units: 3
Class Schedule: ACT103: Synchronous: Saturday 7:00 am – 10:00 am
Asynchronous: Saturday 10:00 am – 11:00 am
ACT101: Synchronous: Saturday 11:00 am – 2:00 pm
Asynchronous: Saturday 2:00 pm – 3:00 pm
ACT102: Synchronous: Saturday 3:00 pm – 6:00 pm
Asynchronous: Saturday 6:00 pm – 7:00 pm

Course Learning Outcomes:

At the end of this course, the student will be able to:
1. Gain substantial knowledge and information on financial management that will help students in
seeking a career in the field of finance.
2. Have a strong background on the management of working capital.
3. Apply effective and efficient financial management in a given business organization.
4. Integrate and assimilate financial management and accounting principles into meaningful
application through real-life case problem analysis
5. Identify and relate well with financial management and accounting principles, issues and
practices surrounding the finance profession.

About the Instructor:

PROF. MICHAEL ANGELO M. MANAYAO, CPA, MBA
• Master in Business Administration – Far Eastern University
• Graduated from Baliwag Polytechnic College (Cum Laude) – Batch 2018
• Member, PICPA Bulacan

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(+63) 927-533-0342 – (+63) 923-949-5265 admissions-nubaliwag@nu.edu.ph
MODULE 8 – WORKING CAPITAL MANAGEMENT

I. Learning Outcomes
The learners are expected to be able to:
1. Understand the concept of working capital management.
2. Know the importance of working capital management.
3. Understand and calculate the operating cycle and cash conversion cycle of a business.
4. Know the alternative policies in financing investment in current assets.

II. Content

Introduction
Working capital management is associated with short-term financial decision making. Short-term
financial decisions typically involve cash inflows and outflows that occur within a year or less. For
instance, short-term financial decisions are involved when a firm orders raw materials or merchandise,
paus in cash and anticipates selling finished goods in one year for cash. In contrast, long-term financial
decisions are involved when a firm purchases a special equipment that will reduce operating costs over,
say, the next five years.

Working capital management also involves finding the optimal levels of cash, marketable securities,
accounts receivable, and inventory and then financing that working capital at the least cost. Effective
working capital management can generate considerable amounts of cash.

Reasons Why Working Capital Management is Important

1. Working capital comprises a large portion of the firm’s total assets. Although the level of working
capital varies widely among different industries, firms in manufacturing and trading industries more
often than not, keep more than half of their assets in current assets.
2. The financial manager has considerable responsibility and control in managing the level of current
assets and current liabilities.
3. Working capital management 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 working capital management. Without
sufficient liquidity, a firm may be unable to pay its liabilities as they mature. The firm’s profitability
is also affected because current asset must be financed and financing involves interest expense.

Factors affecting the Firm’s Working Capital Policy

There is no single working capital policy that is optimal for all firms or for any single firm in all situations.
The optimal working capital policy is difficult to develop in practice because not all factors are

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controllable by management. The significant factors affecting a firm’s working capital position are as
follows:
1. The Nature of Operations. Working capital requirements differ greatly among manufacturing,
retailing and service organization. For example, retailing firms have a high proportion of total assets
in the current category because they earn return from current assets such as inventory.
2. The Volume of Sales. More current assets such as accounts receivable and inventories are needed to
support a higher level of sales.
3. The Variations of Cash Flows. The greater the fluctuations in the firm’s cash inflows and outflows,
the greater the level of the net working capital required.
4. The Operating Cycle Period. The operating cycle is the length of time cash is tied up in a firm’s
operating process. For example, 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 receipts
and repay the credit. Shortening the operating cycle reduces the amount of time funds are tied up in
working capital and thus lowers the level of working capital required.

Working capital management has become particularly difficult in the declining economic environment
following the recent financial crisis some companies have been stuck with unused inventory while others
refrain from purchasing additional inventory until they see sufficient evidence that consumers would start
spending again. Also, some companies have relied more on trade credit from their suppliers as a substitute
form of financing rather than obtaining short-term loans from financial institutions. Suppliers on the other
hand worry that because of weak economy, customers will not be able to pay them back on time.

Working capital management involves risk-return tradeoffs because the level composition and financing
of working capital always affect both a firm’s risk and its profitability.

Tracing Cash and Net Working Capital

To trace cash movement through the firm’s operation, we must measure the operating cycle as well as
the firm’s 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 time
between paying for working capital and collecting cash from the sale of inventory.
➢ Inventory Conversion Period. The average time required to purchase merchandise or to purchase
raw materials and convert them into finished goods and then sell them.
➢ Average Collection Period. The average length of time required to convert the firm’s receivables
into cash, that is, to collect cash following a sale.

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 ➢ Payables Deferral Period. The average length of time between the purchase of materials and
labor or merchandise and the payment of cash 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. To measure firm’s operating cycle, the following formula can be used:

The Cash Conversion Cycle

The firm’s cash conversion cycle is determined by subtracting the average payment period from the
operating cycle.

How can Operating Cycle be Reduced?

The aim of every management should be to reduce the length of operating cycle or the number of
operating cycles in a year in order to reduce the need for working capital. It is therefore necessary that
the financial managers be able to identify the reasons for prolonged operation cycle and how it could be
reduced.

The following could be the reasons for longer operating cycle 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.

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 ➢ Failure to get credit from suppliers.
➢ Failure to get trade/cash discount.
➢ Inability to purchase goods due to seasonal swings

2. Lack of proper production planning, coordination and control that could result to protracted
manufacturing cycle.
3. Defective inventory policy.
4. Use of outdated machinery, technology as well, poor maintenance and upkeep plant, equipment and
infrastructure facilities.
5. 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
There should be proper production planning and coordination at all levels of activity. Also, a
continuing assessment of the manufacturing cycle, proper maintenance of plant, equipment and
infrastructure facilities and improvement of manufacturing system, technology would help shorten
manufacturing cycle thus shortening operating cycle.

2. Purchasing Management
The purchasing manager should ensure the availability of the right type, quantity and quality of
materials/merchandise obtained at the right price, time and place through proper logistics
management. Further, efforts exerted towards lengthening the credit period of the suppliers,
increasing the rates of trade discount and cash discount would certainly bring favorable outcome to
the company’s deferral payment period.

3. Marketing Management
The sale and production policies should be synchronized. Production of quality products at lower
costs enhances their marketability and saleability. Storage costs would likewise be minimized. The
marketing people should strive to continually develop effective advertisement, sales promotion
activities, effective salesmanship and appropriate distribution channels.

4. Credit and Collections Policies

Sound credit and collection policies will enable the finance manager to minimize investment in
working capital particularly on inventory and receivables.

5. External Environment
The length of operating cycle is equally influenced by external environment. The financial manager
should be aware and sensitive to fluctuations in demand, entrants of new competitors, government
fiscal and monetary policies, price fluctuations, etc. to be able to anticipate and minimize any adverse
impact of the changes to the company.

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Alternative Policies as to the Size of Investment in Current Assets
There are at least three alternative policies regarding the total amount of current assets carried:
1. Relaxed Current Asset Investment Policy
This is a policy under which relatively large amounts of cash, marketable securities and inventories
are carried and under which sales are stimulated by granting liberal credit terms resulting in a high
level of receivables. In this policy, marginal carrying costs of current assets will increase while
marginal shortage costs will decrease.

2. Restricted Current Asset Investment Policy

This is a policy under which holdings of cash, securities, inventories and receivables are minimized.
Marginal carrying costs of current assets will decrease while marginal shortage costs will increase.

3. Moderate Current Asset Investment Policy

This is policy that is between the relaxed and restricted policies. This policy dictates that the firm
will have just enough current assets so that the marginal costs and marginal shortage costs are equal,
thereby minimizing total costs.

Costs Relevant to Investments in Current Assets

Carrying costs are the cost associated with having current assets. Generally, they consist of (a)
opportunity costs associated with having capital tied up in the current assets instead of more productive
fixed assets and (b) explicit costs which are costs necessary to maintain the value of the current assets
(e.g., storage costs)

Shortage costs are the costs associated with not having current assets and can include (a) opportunity
costs such as sales lost due to not having enough inventory on hand and (b) explicit transaction fees paid
(e.g., extra shipping costs, interest expense for money borrowed) to replenish the particular type of
current asset.

Alternative Strategies in Financial Working Capital

In previous section, we looked at the basic determinants of level of investment in current assets. Now we
turn to the financing side of the question.

Effective working capital management requires a set of strategies to manage the level, composition and
financing of a firm’s current assets. Decisions should be based on the simultaneous analysis of their joint
impact on return and risk. These are:

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1. Long-term/Permanent Assets. These consist of property, plant and equipment, long-term
investments and the portion of a firm’s current assets that remain unchanged over the year.
2. Fluctuating or Seasonal Assets. These are current assets that vary over the year due to seasonal or
cyclical needs.

III. Activity – Supplementary

Problems (page 270 to 273)

IV. Activity/Assessment – Visit the MS Teams

V. References
Cabrera, M. and Cabrera, G. (2021-2022) Financial Management, Manila: GIC Enterprises
and Co. Inc.

SM Baliwag Complex, Dona Remedios Trinidad Highway, Brgy. Pagala, Baliwag, Bulacan
(+63) 927-533-0342 – (+63) 923-949-5265 admissions-nubaliwag@nu.edu.ph