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Working Capital Management
Dual Objective:
1. Ensure Liquidity
2. Optimize Profitability
•Profitability measured by the quality of its products in the
market place and the ability of the enterprise to control

•Liquidity measured by the amount of timing of its cash

inflows and outflows.
Profitability Management

- short term assets earn less than investment in long

term assets.
- long term financing cost more than short term

* if you like to EARN MORE, invest in NON

Working Capital Policy

• Conservative – lesser amount of investment on

current assent is made, the greater amount of short
term is used.

• Aggressive – greater amount of investment on

current asset, lesser amount of short term financing
is used.
Working Profitability Liquidity Working
Capital Capital
Investment Policy
Increase Lower Higher Conservative
Decrease Higher Lower Aggressive

To working capital, increase current assets and/or

decreasing current liabilities.

To working capital, decrease current assets and/or increase

current liabilities
Working Capital Asset

• Permanent Working Capital Asset

• Temporary Working Capital Asset
can either be:
a. Very Conservative Policy
(financing temporary working capital assets w/ long term financing)
b. Moderately Conservative Policy
(partly financing temporary working capital assets with long term financing and
partly short term financing)
c. Aggressive Policy
(financing temporary working capital assets with short term financing)
Working Capital and the Cash
Conversion Cycle
• Working capital can be viewed statically as the
balance between current assets and current liabilities
Working Capital and the Cash
Conversion Cycle
• The cash conversion cycle, which represents the
interaction between the components of working
capital and the flow of cash within a company
• It is the period of time between the outlay of cash
on raw materials and the inflow of cash from the sale
of finished goods, and represents the number of
days of operation for which financing is needed
Cash Conversion Cycle

The length of the cash conversion cycle depends on the

length of:
• The inventory conversion period;
• the trade receivables collection period;
• the trade payables deferral period;
CCC = Inventory days + Trade
receivables days − Trade payables days
• The operating cycle is the length of time it takes a
company’s investment in inventory to be collected in
cash from customers.
• The net operating cycle (or the cash conversion
cycle) is the length of time it takes for a company’s
investment in inventory to generate cash, considering
that some or all of the inventory is purchased using
Operating Cycle and Cash
Conversion Cycle

Collect on Acquire Acquire

Accounts Inventory Pay
Receivable for Cash Suppliers
for Credit

Collect on Sell
Accounts Inventory
Sell Inventory Receivable for Credit
for Credit

Operating Cycle Cash Conversion Cycle

Operating and Cash Conversion
Cycles: Formulas
Average time it
takes to create and
sell inventory
Average time it
takes to collect on
accounts receivable

Average time it
takes to pay its
Objective of Cash Management

Cash as a medium of exchange

• Is a commodity, it is not an investment
• It is used as a medium of exchange in acquiring
plant, machines, equipment and materials and in
securing the labor and suppliers.
• It has to be translated into physical resources and
valuable services to produce products and create
Reasons for Holding Cash

1.Transactional Motive

2.Speculative Motive

3.Precautionary Motive
Economic Cycle


Recovery Recession

Business Life Cycle


Decline or
Maturity Growth

Objective of Current Assets

1. To achieve as low a level of current asset as possible.

2. To achieve a balance between profitability and risk that
contributes to firm’s value.
The lower the current
asset, the better.

Current Asset includes:

• Cash
• Accounts Receivables
• Inventory
• Marketable Securities
Managing Cash Flow
Considering the reasons for maintaining a cash balance, we can
say that the optimum cash maintained by a business is
composed of the following :

 Permanent Cash Balance

It is for precautionary motive and emergency motive.

 Transactional Cash Balance

It is for the normal operating transactions where use of

cash is needed.
Cash inflows
The main cash inflows are:
 payment for goods or services from
 receipt of a bank loan
 interest on savings and investments
 shareholder investments
 increased bank overdrafts or loans
Cash outflows
The main cash outflows are:
 purchase of stock, raw materials or tools
 wages, rents and daily operating expenses
 purchase of fixed assets - PCs, machinery, office furniture, etc
 loan repayments
 dividend payments
 income tax, corporation tax, VAT and other taxes
 reduced overdraft facilities
Cash Flow Management: An Overview
• Beginning Cash Balance
+ Cash Inflows - - - Speeding Up
- Cash Outflows - - - Slowing Down
= Ending Cash Balance
- Desired Cash Balance
= Surplus or Shortage
• If Surplus: Pay off short-term debt or buy marketable securities
• If Shortage: Short-term borrowing or sell marketable securities
Slowing Down Cash Payout
Disbursement Cycle: The total time between when an obligation occurs and
when the payment clears the bank.

Example 1 - Disbursement Cycle Time

Specific Activity Day

Obligation to Supplier 0
Process Invoice from Supplier 10
Run Payables and cut checks 25
Payment clears the bank 35

Total Cycle Time for Disbursement = 35 days

The overall objective within the
Disbursement Cycle is to increase the
cycle time; i.e. delay making payments
until they are due.
Slowing Down Cash Payout
 Mailing checks from locations not close
to customers.

 Disbursing checks from a remote bank.

 Purchasing with credit cards so that the

time required for making payment is
much longer.
• Much of cash management is oriented towards
managing the float.
• Mail Float
• Time spent in the mail or time lapse from the moment a customer mails
a remittance check until the firm begins to process it.
• Processing Float
• Time required to process cash flow transactions or time required for the
firm to process remittance checks before they can be deposited in the
• Clearance Float
Time spent trying to clear the bank.
By increasing the float times within disbursements, we
have the use of cash for several more days. This is a
source of spontaneous financing and we can measure
our cash savings.
Speeding Up Cash Receipts
Receipt Cycle: The total time between when products or services are delivered and
when payment from the customer clears the bank.

Example 3 - Calculate Receipt Cycle Time

Specific Activity Day

Begin Services to Customer 0
Issue Invoice to Customer 30
Receive Payment 62
Payment clears the bank 66

Total Cycle Time for Receipts = 66 days

The overall objective within the
Receipts Cycle is to decrease the cycle;
i.e. shorten the time necessary to collect
and have use of cash.
Speeding Up Cash Receipts
 Invoicing customers as quickly as possible.

 Taking immediate action when a customer becomes delinquent.

 Rewarding customers for making early payment by offering a


 Imposing a finance charge on customers that are seriously

Speeding Up Cash Receipts

 Evaluating the financial soundness of customers before

extending credit.

 Issuing monthly statements to remind customers of amounts


 Placing collection centers near customers and/or having

banks control deposits.
Techniques for Lessening Cash
• Cash budgeting
• Providing for unpredictable discrepancies
• Consideration for short costs
• Availability of other sources of funds
Marketable Securities
Objectives of Marketable Securities
• To maintain levels of marketable securities to ensure
that they are able to quickly replenish cash balances
• To obtain higher returns than is possible by
maintaining cash