WORKING CAPITAL

MANAGEMENT
 This lesson will help you understand
working capital management. The
different working capital financing
policies is discussed in this lesson as well
as the cash management, receivables
management, and inventory
management
After this lesson, you are expected to
explain tools in managing cash,
receivables, and inventory and
describe concepts and tools in
working capital management.
OPENING CASE
Joe, the proprietor of Mango Merchandising
has reported a profitable
Result of operations over the past three years. It is
with no doubt that the entity was able to generate
sufficient earnings to keep a stable financial health
for the firm. However, Joe has noted some
problems confronting the firm despite its
profitable operations result. First, Joe, observes
that although he is able to sell a lot of his
merchandise, he often experience times wherein
he is overstocked of goods or worst , there is an
under stock of goods that leads to loss sales. Aside
from that, since a majority of its customers
purchase on credit, Joe has observed that it has
been taking the firm
too long to collect its customer receivables. Some
of its customers are even to the point of
defaulting when payments are scheduled to be
made. Given this collection problem encountered
by Joe, he finds himself in a disadvantages
situation when it comes to paying his obligations
to his suppliers when they become due.
Joe is now in trouble. The business is earning, but
how come, he is experiencing financial
difficulties?
WORKING CAPITAL MANAGEMENT
specifically refer to the efficient management of
the firm’s current assets (cash, receivables and
inventory) and current liabilities (short term
payables). Through working capital management,
managers are given the challenge to balance risk
and profitability that comes along each current
asset and liability in
to positively contribute to the firms value.
WORKING CAPITAL MANAGEMENT is
the proper administration of current assets and
liabilities. Good working capital management
enables the firm to pay its financial obligation,
establish good relationships with suppliers and
creditors, and improve the earnings of the
company.
A working capital management is
important because it can improve the
business profit. It allows the company
to pay its financial obligations and
leads to the growth and survival.
Working capital refers to the firms current
assets, which represents a position of
investment that circulates in one form to another
in conducting the ordinary course of business.
An example of this is CASH being converted to
inventories for sale, that is eventually converted
to receivables once they are sold on account
and converted
back to cash, once these receivables have been
collected.
Current liabilities are also part of the firms
working capital management since these are
short-term obligations, maturing within one
year or less. Most sources of current liabilities
are obligations from suppliers for goods
purchased, salaries to employees and
other obligations incurred as part of the ordinary
course of business.
CURRENT ASSETS like cash, accounts
receivable, inventories, and prepaid
expenses used in the operations of the
business are called working capital. It
means that they can be converted into cash,
sold, or exchanged.
The amount of resources used in the
operations of the business can be
affected by current liabilities like trade
accounts payable.
Net Working Capital refers to the difference
between the firms current assets and current
liabilities. If the firms current assets exceeds its
current liabilities, the firm has a positive working
capital. On the other hand, if current liabilities
exceed current assets, the firm has a negative
working capital.
NET WORKING CAPITAL is the
difference between current assets and
current liabilities.

Net Working capital = Current

Assets – Current Liabilities
EXAMPLE:
The total assets of Masipag
Corporation amounts to Php
20,000,000 and its total current
liabilities amounts to Php 16,000,000.
 The working capital of Masipag
Corporation is Php 20,000,000

 The net working capital of Masipag

Corporation is Php 4,000,000
(Php 20,000,000 – Php 16,000,000.00)
OPERATING CYCLE AND CASH
CONVERSION CYCLE

 Operating Cycle = Days of Inventory +

Days of Receivable
DAYS OF INVENTORY (Inventory
Conversion Period) is the average
number of days to sell its inventory.
DAYS OF RECEIVABLE
(Receivable Conversion Period) is the
time it takes to collect cash from the
sale of the inventory
The CASH CONVERSION CYCLE
(CCC) is a metric that expresses the time
(measured in days) it takes for a company
to convert its investments in inventory and
other resources into cash flows from sales.
The operating cycle is 173 days which means
that it is longer to recover its inventory. A
shorter cycle is preferred because it means
business is more efficient and has enough cash
to meet financial obligations. The company
must find ways to decrease its operating cycle.
It means that the company takes 149
days to get the cash from its
investments in inventory and accounts
receivable.
ACTIVITY:
Direction: Try to guess the
following pictures.
 WORKING
CAPITAL
FINANCING
POLICIES
1. MATURITY-MATCHING WORKING
CAPITAL FINANCING POLICY
The permanent working capital
requirements should be financed by long-
term sources while temporary working
capital requirements should be financed by
short-term sources of financing.
2. AGGRESSIVE WORKING CAPITAL
FINANCING POLICY
Some of the permanent working capital
requirements are financed by short-term sources of
financing. Managers use this kind of policy
because long-term sources of funds have a higher
cost as compared to short-term sources of
financing.
By financing some of the permanent
working capital requirements with short-
term sources of financing, the financing
cost is minimized, which in turn,
improves net income.
But what is the TRADE OFF? Since it is
short-term, the debt has to be paid soon and
the company may not yet have enough cash
by the time the debt matures. This refers to
liquidity risk and this risk increases with the
aggressive working capital financing policy.
3. CONSERVATIVE WORKING
CAPITAL
FINANCING POLICY
There are of the temporary working
capital requirements that are financed by
long-term sources of financing.
Some companies use this policy because
they don’t want to be stressed too much and
to be focused on other company’s matter. It
can also be their management style. It will
be easy for the company to raise funds
PERMANENT OR FIXED
WORKING CAPITAL refers to the
minimum level of current assets
required by a firm to continue the
operations of the business and to cover
up all current liabilities.
TEMPORARY WORKING CAPITAL is
the difference between net working capital
and permanent working capital. It can help
the business survive during the slack
season. Temporary working capital = Net
working capital – permanent working
capital.
LONG-TERM SOURCES OF
FINANCING include long-term debt
like loan from a bank and equity such
as common stock and preferred stock.
Short-term sources include short-term
loans from a bank.
 Before we proceed for the
continuation of our lesson, let us
review first the process of solving
the firm’s operating cycle and the
firm’s cash conversion cycle.
A. Compute the following.
1. Average Inventory
2. Average Receivable
3. Average Payable
4. Inventory Turnover Ratio
5. Days of Inventories
6. Receivables Turnover Ratio
7. Days of Receivable
8. Payables Turnover Ratio
9. Days of Payable
10. Operating Cycle
11. Cash Conversion Cycle
 ACCOUNTS BEGINNING ENDING

INVENTORY 3,500,000 6,300,000

RECEIVABLES 980,000 1,500,000

PAYABLES 385,000 850,000

NET CREDIT SALES 7,450,000

COST OF GOODS SOLD 4,250,000

2. DEFG Company has an inventory conversion
period of 66 days, a receivable conversion
period of 35 days, and payable conversion
period of 26 days.
1. Calculate the firm’s operating cycle.
2. Calculate the firm’s cash conversion cycle
CASH MANAGEMENT
Cash management involves the
maintenance of a cash and marketable
securities investment level which enables the
company to meet its cash requirements and
at the same time, optimize the income of idle
funds
 The objectives of cash
management are to meet the financial
obligation of the firm and to avoid
losses in the normal operation of the
business.
CASH BUDGET is used in determining the
cash needs of the company. It shows the
projected cash receipts and cash
disbursements for a particular period of time.
(Cash budget was discussed in Lesson 4)
RECEIVABLES MANAGEMENT
Providing credits to a customer is one way of
increasing sales and gaining additional customers.
Properly managing the accounts receivable lets the
company continue its operations. To minimize loss
from accounts receivable, the customer must be given
credit terms and credit evaluation must likewise be
done.
 The use of the 5C’s of credit will allow the
firm to carefully assess the customer’s ability to
repay its obligations along with the level of risk
that the firm will be subjected to once it decides
to grant credit to the customer. It requires
experience to fully assess and review the credit
worthiness of customers and subsequently
decide.
INVENTORY MANAGEMENT
Inventory is the stocks of the
product the business is selling and
the parts or raw materials that made
up the product.
 Inventory management is very
important for manufacturing and
merchandising companies especially
companies with perishable products. There
should be a sufficient number of inventories
to secure the smooth operations of the
business.
 The objective in managing inventory is to
convert it as quickly as possible to cash without
losing sales due to stock outs. Therefore, the
financial manager plays a crucial role in
overseeing that the firm maintains an appropriate
quantity of inventory – not too much and not too
little.
 Maintaining too much inventory implies
that the firm incurs more costs associated with
carrying these inventories. However, carrying
too little inventory quantities might lead to
possible stock outs that could further lead to
lost sales, and worst, lost customers.
 The following are the list of
internal controls that management
should consider in to protect their
inventories.
1. Separating the custodial functions
from recording functions. The
company should not allow the
assignment of custodial functions
from recording functions to one
person to avoid manipulation of
records.
2. AGING OF INVENTORIES. It
allows the company to decide what to
do with slow-moving items. For
example, they can use bundling or buy
one take promo.
3. ABC ANALYSIS. This approach
categorizes the inventories according to their
values. A is considered the most important
inventory or with the highest values, B is
considered the average item and C is the
least important or has lower value
EXERCISE:
Directions: Answer the question in three (3) to
five (5) sentences.

How do we apply the concepts of

working capital management in our
daily lives?