WORKING CAPITAL MANAGEMENT

Working Capital Management – refers to the administration and control of current assets and current
liabilities to maximize the firm’s value by achieving a balance between profitability and risk.

Working Capital Financing Policies

1. Matching Policy (also called self-liquidating policy or hedging policy) – matching the maturity of
a financing source with an asset’s useful life
- Short-term assets are financed with short-term liabilities.
- Long-term assets are funded by long-term financing sources.
2. Conservative (Relaxed) Policy – operations are conducted with too much working capital;
involves financing almost all asset investment with long-term capital.
3. Aggressive (Restricted) Policy – operations are conducted on a minimum amount of working
capital; uses short-term liabilities to finance, not only temporary, but also part or all of the
permanent current asset requirement.

Cash Management – involves the maintenance of the appropriate level of cash and investment in
marketable securities to meet the firm’s cash requirements and to maximize income on idle funds.

Reasons for Holding Cash

1. Transaction Purposes – firms maintain cash balances that they can use to conduct the ordinary
business transactions; cash balances are needed to meet cash outflow requirements for
operational or financial obligations.
2. Compensating Balance Requirements – a certain amount of cash that a firm must leave in its
checking account at all times as part of a loan agreement. These balances give banks additional
compensation because they can be relent or used to satisfy reserve requirements.
3. Precautionary Reserves – firms hold cash balance in order to handle unexpected problems or
contingencies due to uncertain pattern of cash inflows and outflows
4. Potential Investment Opportunities – excess cash reserved are allowed to build up in anticipation
of a future investment opportunity such as a major capital expenditure project.
5. Speculation – firms delay purchases and store up cash for use later to take advantage of
possible changes in prices of materials, equipment and securities, as well as changes in
currency exchange rates.

The Concept of Float in Cash Management

Types of Floats:
1. Mail Float – peso amount of customers’ payments that have been mailed by a customer but not
yet received by the seller.
2. Processing Float – peso amount of customers’ payments that have been received by the seller
but not yet deposited.
3. Clearing Float – peso amount of customers’ checks that have been deposited but not yet cleared.
Cash Management Strategies
1. Accelerate cash collections
2. Control disbursements
3. Reduce the need for precautionary cash balance

OPERATING CYCLE – the amount of time that elapses from the point when the firm inputs materials
and labor into the production process to the point when cash is collected from the sale of finished
goods.

ECONOMIC CONVERSION QUANTITY (Optimal Transaction Size) – the amount of marketable

securities that must be converted to cash (or vice versa), considering the conversion costs and
opportunity costs involved.

Marketable Securities – short-term money market instruments that can easily be converted to cash.

Reasons for holding Marketable Securities

1. MS serve as substitute for cash balances
2. MS serve as a temporary investment that yields return while funds are idle
3. Cash is invested in MS to meet known financial obligations such as tax payments and loan
amortizations

Accounts Receivable Management – formulation and administration of plans and policies related to
sales on account and ensuring the maintenance of receivables at a pre-determined level and their
collectability as planned.

Ways of Accelerating Collection of Receivables

1. Shorten credit terms
2. Offer special discounts to customers who pay their accounts within a specified period
3. Speed up the mailing time of payments from customers to the firm
4. Minimize float, that is, reduce the time during which payments received by the firm remain
uncollected funds

Aids in Analyzing Receivables

1. Ratio of receivables to net credit sales
2. Receivable turnover
3. Average collection period
4. Aging of accounts
INVENTORY MANAGEMENT - Formulation and administration of plans and policies to efficiently and
satisfactorily meet production and merchandising requirements and minimize costs relative to
inventories.

Economic Order Quantity – the quantity to be ordered, which minimizes the sum of ordering and
carrying costs.

2 𝑥 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑥 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑

√
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

Assumptions of the EOQ Model:

1. Demand occurs at a constant rate throughout the year.
2. Lead time on the receipt of the orders is constant.
3. The entire quantity ordered is received at one time
4. The unit costs of the items ordered are constant.
5. There are no limitations on the size of the inventory.

Reorder Point – when to reorder is a stock-out problem. The objective is to order at a point in time so
as not to run out of stocks before receiving the inventory ordered but not so early that an excessive
quantity of safety stock is maintained.

SHORT-TERM FINANCING
1. Accounts Payable – the major source of unsecured short-term financing.

➢ Stretching accounts payable – a firm should pay the bills as late as possible without
damaging its credit rating. When a firm can stretch the payment of accounts payable, the
cost of foregoing the discount is reduced.

2. Bank Loans
a. Single-payment notes – if the interest is payable upon maturity, the effective interest rate is
equal to the nominal rate.
b. Discounted note – the effective interest rate is higher than the nominal rate.
c. Compensating balance – an arrangement whereby a borrower is required to maintain a
certain percentage of amount borrowed as compensating balance in the current account of
the borrower.