Subject: Financial Management

Author: Mr. Viron R. Calma

Editor:
Reviewer:
Lesson 6: WORKING CAPITAL and CASH MANAGEMENT
(Weeks 12-13)

Description of the Lesson:

A company requires financing whether from creditors or from

owners to acquire assets to generate sales or revenues. The need for assets
creates financing requirement. Few sources of financing are available
automatically. Few businesses can meet all their financing needs through
funds provided by operations and trade creditors. Sources of financing
could be both short-term and long-term though the focus of this chapter is
on the short-term known as working capital management, which is only a
part of financial management.

Objectives:

At the end of this lesson, the student is expected to do the following:

1. Understand the concept of working capital management;

2. define and know the net working capital;
3. learn the related trade-off between profitability and risk; and
4. describe the cash conversion cycle and the key strategies for managing it.

Day 1: Pre-assessment (What I know)

Direction: Identify whether the following accounts is Current Asset (CA) or Current Liability (CL).

Date Accomplished: ____________________________

1. Accounts Payable _____

2. Accounts Receivable _____
3. Cash _____
4. Notes Payable _____
5. Inventory _____

Day 2: Lesson Content (What’s new)

How was activity above? I hope you enjoyed answering it. Before we proceed with our lesson I want
you to ask yourself the following questions.

1. How much should a company invest in current assets?

2. How should a company finance such investment?

Now, let’s start our lesson.

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 A. Working Capital Management

Working capital or short-term financial management refers to the administration and

control of the more liquid resources to make sure that they are sufficient to cover day to day
business operations including anticipated contingencies. It generally deals with managerial
decisions regarding current assets and how they are financed.

Current assets include inventory, accounts receivable, marketable securities, and cash.

Current liabilities include notes payable, accruals, and accounts payable.

The following conditions should be attained:

1. Cash – should be enough to support firm’s operation.

2. Accounts Receivable – should not be too lax nor too strict in granting credits
3. Inventories – should be enough to support market demand
4. Current Liabilities – to be prudent in making use of the time before it finally
pays off its obligations

B. The Working Capital

Working Capital is the difference of total current assets and total current liabilities. It is
analyzed as the ability to meet current obligations as they come due using current ratio analysis.
However, the use of current ratio must be made with care and caution. A good current ratio may
only imply liquidity position, but this may not be absolutely true. Careful and deeper analysis on
the composition of the current assets must be made. Example would be the inclusion of old
accounts receivable and non-moving inventories.

Effective management of working capital will improve the firm’s overall return on
investment performance. Usually, the firm’s goal is to minimize net working capital. This could
be achieved by:

1. Having faster collection of cash from sales or service revenues,

2. Increasing inventory turnover,
3. Slowing down disbursements to suppliers or securing longer credit terms.

Day 3: Let’s Keep on Learning!

C. Uses and Importance of Working Capital Management

Working capital investments are made to support day-to-day operations and sales
activities. These include:

1. The amount of cash on hand and in bank to be maintained.

2. The amount of credit to be extended to customers.
3. The number of days extended to credit customers.
4. The amount and type of inventories on stock to be maintained.

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 5. The amount of securities or temporary investments to be made.

Source: https://www.racmacs.com/
D. Objectives of Working Capital Management

1. To generate additional income for the business

2. To reduce the amount of investment needed to support sales and production

These objectives will be generally affected by the following factors:

1. The general nature of the business
2. The cost and length of the operating process
3. Product or service competitive conditions and seasonal variations
4. Government regulations
5. Self-imposed internal policies and commitments
6. Operational efficiencies

E. Advantages of Adequate Working Capital

a. Solvency of the business. It helps in maintaining solvency of the business by providing

uninterrupted flow of production.
b. Goodwill. Sufficient working capital helps in creating and maintaining goodwill.
c. Easy loans. A high solvency and good credit standing can arrange loans from banks and
others on easy and favorable terms.
d. Cash discounts. Enables a concern to avail cash discounts on purchases and hence it
reduces cost.
e. Regular supply of raw material. Sufficient working capital ensure regular supply of
raw materials and continuous production.
f. Regular payment of salaries, wages and other day to day commitments. A company
which has ample working capital can make regular payment of salaries, wages and other
day to day commitments which raises morale of its employees, increases their efficiency,
reduce costs and wastages.
g. Ability to face crisis. Enables a concern to face business crisis in emergencies such as
depression.
h. Quick and regular return on investments. Enables a concern to pay quick and regular
dividends to its investors as there may not be much pressure to plough back profits which
gains the confidence of investors and creates a favorable market to raise additional funds
in future.
i. Exploitation of favorable marker conditions. Only concerns with adequate working
capital can exploit favorable market conditions such as purchasing its requirements in
bulk when the prices are lower and by holding its inventories at higher prices.
j. High morale. Creates an environment of security, confidence, and high morale and
created overall efficiency in a business.

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 The management is to ensure that the firm has adequate working capital to run its business
operations smoothly. It should have neither excess working capital nor inadequate working
capital.

Day 4-5: Lets’ Keep on Learning!

F. Cash Management

Cash is a “non-earning” asset in the sense that cash itself or commercial checking account earns
no interest or very little interest. It is needed to pay for labor, raw materials, taxes, debts, or
dividends and to buy fixed assets.

Cash Management refers to the most effective way of handling cash or its equivalent, in manner
intended to result in its most efficient use.

Some important cash management issues that a financial officer must always have in mind are:

1. Cash is the most important and challenging resource to manage.

2. The optimal cash level is influenced by a subjective factor.
3. Effective management of the cash collection cycle can be both reduce the demand for
cash and increase its supply.
4. The normal operating cycle begins with cash, extends to the purchase of materials,
and then to the exchange of those materials for receivables, and ultimately the
collection of receivables brings cash back to the firm. Thus, the normal operating
cycle is a cash-to-cash cycle.
5. Sound cash management techniques are based on a thorough understanding of the
cash flow process, such as:
a. Cash holdings are increased from several external sources on an irregular
basis,
b. Irregular cash outflows reduce the firm’s cash balance, and
c. Other major sources of cash arising from internal operations occur on a
regular basis such as collections of accounts receivable.
6. Trying to have an acceptable balance between holding too much cash and holding too
little cash.
7. That a large cash investment minimizes insolvency but sacrifices profitability.

Source and Reference: Financial Management (Book) by

Payongayong, Luzviminda S., et.al.

Day 6: Post-Assessment (What I have learned?)

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Good morning. How was the lesson yesterday? I hope you enjoyed the lesson. Today, I am encouraging
you to review your notes. After reviewing, answer the activity below.

Activity 1: Write the correct answer on the space provided.

Date Accomplished: ____________________________

________________1. It refers to the administration and control of the more liquid resources to make
sure that they are sufficient to cover day to day business operations including anticipated contingencies.

________________2. It is the difference of total current assets and total current liabilities.

________________3. It refers to the most effective way of handling cash or its equivalent, in manner
intended to result in its most efficient use.

________________4. Give an example of a current asset.

________________5. Give an example of a current liability.

Activity 2: Discussion. Write your answer in a yellow sheet of paper.

Date Accomplished: ____________________________

Instruction: Discuss at least three (3) important cash management issues

that a financial officer must always have in mind.

Congratulations! I am happy that you were able to finish our module on Working
Capital and Cash Management. Now I am encouraging you to share with me, what is your most
favorite part of this module? Your answer will help me improve the module for our next topic. Please
write your answer on the space provided.

____________________________________________________________________________________
____________________________________________________________________________________
REMINDERS:

Things you have to remember before you finish this module.

1. Keep the following and put it in your portfolio

-Notes and activities written on one whole sheet of short bond paper.
2. If you have questions, clarification and suggestions please send a message to your teacher via SMS or
CHAT.

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