Name:

Registration number:

Assignment: 3

Class: BBA-6

Course: Financial Management

Submission on: May 18, 2020

Submit to: Sir Hassan Zada

 Working Capital Management

Every business has to put aside a sum of money to handle daily business operations. Ideally, all
short-terms assets should be purchased by short term funds however at times there is need for
cash other than meeting short term liabilities; for example, paying back investor before account
receivables are collected. For such circumstances company uses a portion of long term fund to
acquire current assets to meet day to day business needs. Having too much of current assets is
waste of assets that could otherwise be invested for more profit; whereas having too little will put
firm at the brink of bankruptcy. Managing this side of business is known as working capital
management. There are two typed of working capital:

Gross Working Capital

Adding all the current assets of a company will give us the gross working capital. Current assets
include cash, marketable securities, account receivables and inventory.

Net Working Capital

After fulfilling all current liabilities the assets that is left is the net working capital. It is given by
net working capital = current assets – Current liability. The business relies on this portion of the
assets to meet the current financial obligations.

Operating & Non-Operating Current Asset

Operating current assets are essential for functioning of the business. This is the capital that we
talk about in the working capital management. The Non-operating current asset is the portion of
capital that remains liquid until a suitable investment opportunity arrives. It is not spent on
working capital.

The cash Conversion Cycle

The inventory purchased is on credit and has to be paid sooner than the cash flows are generated.
It takes time first to sell inventory (Inventory Conversion Period) then to collect cash (Average
collection period) Total number of day it takes to sell the inventory and collect cash is the cash
conversion cycle.
 Day 0 Day 50 Day 110

Inventory Purchased Inventory Sold Collect Cash

Let’s say will receive cash after 110 days. But we might have to pay the supplier after 40 days.
In this case payable differed period is 40 days where as cash conversion period is 110 days.
Which means for 40 days we will have no cash, therefore a portion of current assets is financed
by long term asset and we call it working capital management.

Working Capital Management Policies

The policies provide the framework for how much current assets should be maintained. Too
much current asset will decrease the profits where too little will be take away liquidity. There are
three policies in this matter:

1. Relaxed Policy

Relative high amount of current assets are maintain by the firm following this policy. The
company can easily afford to pay back its creditors, salaries and other current obligation before
the cash conversion period some and still have some asset in reserve. The company debtors are
also at ease as the portion of receivable is also high.

2. Restricted Policy

Relative low level of current assets is maintained. All the extra cash is invested in long term
projects and little liquidity is maintained by the company. Profit increase by adopting this policy
but it can be risky at times.

3. Moderate Policy

Medium level of current assets is maintained as to keep profitability moderate while still being
able to fulfill current financial obligations.