• WWorking capital

tools and techniquesT

 OBJECTIVES
• Understand the conversion cycle
of working capital
• Solve problems related to
conversion cycle.
• Identify the benefits of tools
and techniques of working capital
in relation to everyday life
• Having a thorough
knowledge about working
capital tools and techniques
helps one to have better
and sound decision.
THINKING TIME…………

• Would it be better for a

business to have a lot of cash
on hand? Why or why not?
CASH CONVERSION CYCLE……..
….REFERS TO THE AVERAGE TIME IT
TAKES FOR CASH TO GO OUT
THROUGH PAYMENT OF RAW
MATERIALS AND FOR CASH TO
ENTER THROUGH THE COLLECTION
OF RECEIVABLES.
BUSINESS DIFFER IN THEIR
CONVERSION CYCLE
1. Terms of purchase and sales
2. Conversion period
3. Credit and collection policy
 ACTIVITIES USUALLY COMMON
AMONG BUSINESS IN THEIR CASH
CONVERSION CYCLE:
• 1. Purchase of raw materials- refers to the
period when the business places an order
to buy the necessary raw materials
• 2. Payment of purchases- the day when the
purchase raw material into finished
products
• 3. Production process- conversion of raw
materials into finished
• 4. Selling of finished goods- goods are
sold to customers
• 5. Collection of receivables- period where
the receivable arising from sales on
accounts is collected or converted into
cash.
 CASH CONVERSION CYCLE PERIOD

• 1. Payable deferral period- length of time from the day the raw
materials are purchased or received up to the time is made
• 2. Inventory conversion period- refers
to length of time it takes to convert
raw materials into finished products.
• Starts from the time raw material are
received up to the time goods are
produced
• 3. Receivable collection period-
period refers to the length of
time from the selling of goods
on account up to the full
collection of credits.
CASH CONVERSION CYCLE
• Example
• Tim’s Tackle is a retailer that sells outdoor and fishing
equipment. Tim buys its inventory from one main vendor
and pays its accounts within 10 days in order to get a
purchase discount. Tim has a fairly high inventory
turnover ratio for his industry and can collect accounts
receivable from his customer within 30 days on average.
• Tim’s days calculations are as follows:
• days inventory turn over: 15 days
• days accounts receivable turn over: 2 days
• days payable outstanding: 12 days
Calculate the cash conversion
cycle. Answer: 5 days
• Tim’s cash conversion cycle is 5 days. This
means it takes Tim 5 days from paying for his
inventory to receive the cash from its sale. Tim
would have to compare his cycle to other
companies in his industry over time to see if his
cycle is reasonable or needs to be improved.
Example

Calculate and analyze the cash

conversion cycle for Hewlett-Packard
(NYSE: HPQ) and Apple, Inc. (NYSE:
AAPL) based on the information
given below (as obtained from
Morningstar):
Solution
Cash conversion cycle for HPQ for 2012 =
52.51 + 27.27 – 55.51 = 24.27
The following table shows cash
conversion cycle for both companies for
the three years.

2012 2013 2014

HPQ 24.27 20.76 11.09
AAPL -52.12 -44.51 -48.64
 INTERPRETATION FOR APPLE
CONVERSION CYCLE
• AAPL has negative cash conversion cycle of 44 to
52 days during the three-year period which
suggests an exceptionally good working capital
management. It means that AAPL could sell and
receive cash from its sales even 44 to 52 days
before it actually made payments against its
production inputs, which is impressive.
 INTERPRETATION FOR HPQ
• HPQ on the other hand drastically improved its
cash conversion over the three years i.e. from
24.27 in 2012 to 11.09 in 2014, which suggests
significant improvement in efficiency of the
company. Still HPQ’s working capital
management is not as good as AAPL. AAPL
has been able to leverage its very strong
market position to receive generous credit
terms from suppliers.
 CASH CONVERSION CYCLE USING
FINANCIAL STATEMENTS INFORMATION
Inventory conversion period
= inventory / cost of sale per day
Receivable conversion period
= receivables / (sales/360)
Payable deferral period
= Payables / purchases per day
Payable deferral period
=payables / (cost of sales/360 days)
CASH MANAGEMENT TOOLS AND
TECHNIQUES
 CASH MANAGEMENT TOOLS

Financial management mechanism that

determines the expected cash inflows and
cash requirement
 LIQUIDITY
• Primary objective in working capital
management
 CASH MANAGEMENT TOOLS
1. cash budget preparation
2. Cash break-even computation
3. Cash management model
 CASH BUDGET PREPARATION
Cash budget reflects the expected cash
inflows and the corresponding cash
outflows from various business activities.

Reflects a need for external borrowing

 CASH BREAK-EVEN
COMPUTATION

• Determines the amount of cash needed for the

total cash outlays requirement to be equal with
the total cash inflow coming from the cash sales.
• Cash sales below the cash break-even point
means expected shortage in handling the cash
operating activities of the business
 2 TYPES OF CASH OUTLAYS
1. Fixed cash outlays- cash requirements
that remains constant during the month or
period
2. variable cash outlays- cash requirement of
the business that vary with the volume of
sales.
• Cash contribution margin= the excess of
cash after deducting variable outlays from
cash sales.
 STEPS TO DETERMINE THE
BREAK-EVEN POINT
Step 1:
• Determine the cash contribution margin:
Cash sales XXXXXX
Less: variable cash payments XXXXXX
Cash contribution Margin XXXXXX
• Cash Contribution Margin

In words, the contribution margin is the amount

of money a company has to cover its fixed costs
after it pays all of its variable expenses.
It is also the amount, after covering fixed costs,
that contributes to the net operating profit or net
operating loss of the business firm.
• In equation form, the contribution margin is:
• Contribution Margin = Sales Revenue -
Variable Expenses
• On a per unit basis, contribution is calculated
as:
• Contribution Margin per unit of sales = Sales
Revenue per Unit - Variable Expenses per Unit
• Contribution Margin - Fixed Costs = Net
Operating Profit or Loss
• STEP 2:
DETERMINE THE CASH
CONTIBUTION MARGIN RATIO

Cash Contribution Margin XXXX

Divide by: Cash Sales XXXX
Cash contribution Margin Ratio XXX
Contribution Margin Ratio

• is the contribution margin as a percentage

of total sales.
• In this formula, you use the total contribution
margin, not the unit contribution margin.
• Example of a cash contribution margin
ratio:
• P40,000/P100,000 X 100 = 40%.
• This means that for every Peso increase in
sales, there will be a 40 cents increase in
the contribution margin to cover fixed
costs.
• Step 3:

Determine the cash break even point:

Fixed cash outlay XXXX

Divide by: Contribution Margin Ratio XXXX
Cash Break-even XXXX
• Example:
Production data and other related information of
Rolly Processing Company are as follows:

Selling Price per Unit P 25

No. of units produced and
Sold monthly 800,000
Monthly Fixed cash payments P 2,640,000
 REQUIRED: COMPUTE THE FF:
• 1. Cash contribution Margin
• 2. Cash Contribution Margin Ratio
• 3. Cash Break-even

• For the past years RPC has experienced a

variable monthly cash payment of 45% of
sales.
 ANSWER:
• CCM= P 11M
• CCMR= .55
• CBEP= P 4,800,000
 INTERPRETATION
• Rolly Processing Company should have a
cash sales of not less than P4,800,000
during the period to avoid incurring cash
deficit.
OBJECTIVES OF CASH MANAGEMENT
 FACTORS DETERMINING CASH NEEDS

1.Synchronization of cash flows

2.Consideration of short costs
3.Position of accounts receivables
4.Operating and cash cycle
5.Control of cash disbursements
6.Nature of product/ business
7.Management’s attitude towards procurement
8.Availability of other sources of funds
 CASH MANAGEMENT MODELS
TO DETERMINE WHAT WOULD BE THE
OPTIMUM CASH BALANCE THAT SHOULD BE
MAINTAINED.

1.William J. Baumol model

2.Merton Miller and Daniel Orr model
ABC Corp. has estimated that it will use
2,400,000 of cash during the next budgeted
year. It intends to hold cash in a
commercial bank which pay interest at 10%
per annum. For each withdrawal, the
company incurs expenditure of 150,000.
What is the optimal size for each
withdrawal?
 SOLUTION

•  
C=
0.10
C = 8,485,281.37
CASH MANAGEMENT MODELS
CASH MANAGEMENT MODELS
 ILLUSTRATION

A company has a policy of maintaining a

minimum cash balance of Php 100,000. the
standard deviation in daily cash balance is
10,000. the interest rate on a daily basis is
0.01%. The transaction cost for each sale or
purchase of securities is PhP 50. Compute the
upper control limit and the return point as per
the Miller-Orr model.
SOLUTION
=3
 PROBLEM SOLVING

Let's assume that a manufacturer has a single product and

80,000 units were produced and sold during a recent year.
The selling price was $10 per unit, variable manufacturing
costs were $3 per unit, and variable SG&A expenses were
$1 per unit. The company's fixed manufacturing costs were
$300,000 and its fixed SG&A expenses were $90,000. The
company's contribution margin was $480,000 ($800,000 -
$240,000 - $80,000). The contribution margin per unit was
$6 ($10 - $3 - $1). The contribution margin ratio was 60%
($6/$10 or $480,000/$800,000).
 REQUIREMENT

1. CCM
2. CCMR
3. CASH BREAKEVEN
Thank
you!!!