Chapter 7 – Working Capital

. The working capital cycle (cash operating cycle) is defined as the length of time between paying for
the purchase of goods and receiving cash for subsequent sale

. It can be calculated as:

Working Capital Cycle = Receivables collection period + Raw materials inventory holding period +
WIP inventory holding period + finished goods inventory holding period – Payables payment period

Raw materials inventory holding period =

(Average inventory of raw material/ ANNUAL USAGE) x 365

WIP inventory holding period =

(Average WIP inventory/ Cost of sales) x 365

Finished goods inventory holding period =

(Average inventory of finished goods/Cost of sales) x365

Time period = (B/S Figure/income statement figure) x365

. The faster a firm can ‘push’ items around the cycle the lower its investments in working capital will
be.

Inventory:

The Economic Order Quality model (EOQ) calculate how much inventory to order, if the objective is
to minimise the costs that are directly affect by the order size

- Annual Inventory holding costs

- Annual inventory order costs

√
EOQ = 2 𝑐𝑑
h
Where:

C = The cost of placing one order

D = Demand for the inventory item over the particular period

H = The holding cost of one unit of inventory for that period

Treasury (cash) management:

. There are 4 reasons why a company would want to hold cash:

a) Transactions motive – To meet day to day obligations

b) Finance motive – to cover major items (e.g. loan repayments, purchase of non-current
assets)
c) Precautionary motive (to cover against unexpected outlays (e.g. accidents)
d) Investments/speculative motive – to take advantage of new investment opportunities

. Therefore the primary aim of good cash management is to have the right amount of cash available
at the right time.