Working Capital

Management
WEEK 6
Prayer
Attendance
 Assets

Resources or
Classified as
things of value
current and non-
owned by an
current
enterprise
 It is cash or cash equivalent which is not
restricted for current use

It is expected to be realized, or is held for sale or

Criteria consumption in the normal course of the
enterprise’s operating cycle

It is held primarily for trading purposes or for

the short term and expected to be realized within
twelve months of the SFP date
  Time between the acquisition of materials entering
Operating into a process and its realization in cash or an
instrument that is readily convertible into cash
cycle of an
enterprise
What are current assets?
 Current Assets

Accounts
Cash Notes Receivable
Receivable

Accrued Interest
Inventories Prepaid Supplies
receivable
 Refers to the current assets used in the operations of the
business

Working Includes cash, accounts receivable, inventories and prepaid

expenses
Capital
The number of resources that a company sets aside to these
working capital accounts can be reduced by current liabilities
such as trade accounts payable and accrued expense payable
Current Assets & Current Liabilites

 Management of these accounts ( both the current assets and current liabilities) is
important because these accounts deal with the day to day operations of the
business
 If the company fails in the management of these accounts, there will be no
expansion to talk about or this can lead to the closure of the company
Benefits

 Good management of working capital accounts allows the company to pay

maturing obligations ON TIME and helps in developing good business
relationships with suppliers and other vendors
 Relieves managers of unnecessary stress and gives them more executive time to
improve the business operations
 Efficient management of working capital accounts can improve the earnings of
the company-coming from savings in financing costs and minimizing possible
impairment losses from inventories
 the value loss of an asset due to the following factors:
Inventory 1. An increase in market competition that causes a reduction in the
selling prices of a company’s products.

Impairment 2. The increase in production costs or merchandising costs that

make products more expensive and these increases are not
reflected in the sale price.
3. Market regulations that cause a decrease in the sale price of
products.
An entity should assess at the end of the reporting period whether its
inventories are impaired, ie, if the carrying amount is greater than the
net realizable value, if inventories are found to be impaired, the cost
of the asset should be reduced to match it to the net realizable value,
this decrease must be recognized in profit or loss.
Impairment occurs when a business asset suffers a
depreciation in fair market value in excess of the
book value of the asset on the company's financial
statements.

Under the U.S. generally accepted accounting

principles (GAAP) assets considered impaired
must be recognized as a loss on an income
statement.

The technical definition of impairment loss is a

decrease in net carrying value of an asset greater
than the future undisclosed cash flow of the same
asset.
Impairment occurs when assets are sold or abandoned because the
company no longer expects them to benefit long-run operations.

Carrying value is an accounting measure of value in which the

value of an asset or company is based on the figures in the
respective company's balance sheet. For physical assets, such as
machinery or computer hardware, carrying cost is calculated as
(original cost - accumulated depreciation). If a company purchases
a patent or some other intellectual property item, then the formula
for carrying value is (original cost - amortization expense).
 Maturity-matching working
capital financial policy
Working
Capital Aggressive working capital
financing policy
Financing
Policies Conservative working capital
financing policy
 Working capital requirements change with the volume of business operations
 As the sales increase, working capital requirements also increase
Ex
A company needs P10M in working capital to support an annual sales of P50M
If the sales increase to 100M, will the 10-Million working capital be enough?
Most likely NO-because with 100M sales, there will be more cash needed for the
operations, more accounts receivable, and if the company is a trading or
manufacturing company, more inventories
 During the year, sales are not the same every month
 This is why companies have slacked season and peak season
 If a company has annual sales of P50M , chances are, these sales are not generated
uniformly throughout the year
 Given this situation, the net working capital requirements during the slack season
are lower than those during the peak season
 The net working capital needed to support an operation during the slack season
represents the PERMANENT working capital requirements while the additional
net working capital needed during the peak season represents the TEMPOORARY
working capital requirements
Maturity Matching Working Capital Policy

 Based on the maturity-matching working capital financing policy, 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
 Long-term sources of financing include long term debt and equity such as
common stocks and preferred stocks
 Short-term sources include short term loans from banks (working capital loans)
Aggressive Working capital financing
policy
 Some of the permanent working capital requirements are financed by the short-
term sources of financing
 Bec. Long-term sources of funds have higher costs as compared to short-term
sources of financing
 By financing some of the permanent working capital requirements with short-term
sources of financing, financing cost is minimized which in turn improves the net
income
 By having this financing policy, the company is increasing the probability that it
will not be able to meet maturing obligation
 In finance, we call this default risk
 Embracing this policy increases default risk
Conservative Working Capital Policy

 Some of the temporary working capital requirements are financed by long-term

sources of financing
 Reasons could be management style
 Top management does not probably want to be stressed too much so that they can
concentrate their efforts on other important concerns that will benefit the company
 The management may also like to preserve their financial flexibility
 This means that if the company is conservatively financed and good investment
opportunities come along the way, it will be easier for the company to raise
additional funds , be it in the form of debt-financing or equity financing
Debt financing-equity financing

 Debt financing occurs when a company raises money by selling debt instruments
to investors. Debt financing is the opposite of equity financing, which entails
issuing stock to raise money. Debt financing occurs when a firm sells fixed
income products, such as bonds, bills, or notes.
 Equity financing is the process of raising capital through the sale of shares.
Companies raise money because they might have a short-term need to pay bills, or
they might have a long-term goal and require funds to invest in their growth
Activity

 Come up with ways on how to manage working capital accounts-CASH,

RECIEVABLES and INVENTORIES
 Ways to be observed to safeguard these assets
Management of Working Capital Accounts
CASH is the most liquid asset of a company but also the asset
most vulnerable to theft
Because of this, there must be proper internal control over cash
that need to be observed to safeguard the asset
 1. Separating cashiering function from the recording or accounting function
A basic internal control system should not allow the assignment of custodial function
and recording function to one person, unless you are the owner
Imagine a cashier of a company who is also the chief accountant. If tempted, this
person may stral cash from the company and manipulate the records so that nobody
can discover that he is stealing
 2. Issuing official receipts for collection and summarizing collections in a daily
collection report
It is important to know the collections from business everyday as these collections
reflect the health of the company
The daily collection report is going to be useful for the next control measure for cash
—depositing collections
3. Depositing collections
A good internal control over cash is by depositing all collections intact
The daily collection report are now compared with the deposit slips to find out if all
collections ae indeed deposited
 Some companies have 24-hour operations like hotels. One practice adopted by
these companies is to have two collection reports and deposits everyday
 To do this, the management has to decide on the cut off-time
 For example, collections from 9am to 2pm have to be deposited before 3pm
 All collections from 2pm to 9am the following day have to be deposited by 10am
 This practice minimizes the amount of cash within the company’s premises and
also minimizes the temptation for theft
 4. Adopting the check voucher system for payments
If all collections need to be deposited, then payments must be made through a check
voucher system
There must be two signatories in the check to provide check and balance
If the business is small, then the entrepreneur’s signature may suffice
However, for big operations, there can be a set of check signatories authorized to sign
depending on the amount of payments
For example: The VP for Finance and VP for Administration are the authorized
signatories for payments amounting to a maximum of P500,000
For payments exceeding that amount, the VP for Finance and the President have to
sign the check
 Having two check signatories minimizes the probability of issuing a flawed
check, either to the wrong payee or an incorrect amount
HOW WILL THE MANAGEMENT DEAL WITH SMALL
PAYMENTS LIKE AMOUNT NEEDED FOR FARE GIVEN
TOA MESSENGER?
 The PETTY CASH FUND will address this concern
 A petty cash which should be minimal in amount will be issued to a petty cash
fund custodian, say the office administrator
 The petty cash fund may be 10,000 or 20,000
 Disbursement from this petty cash fund must be supported by a petty cash
voucher signed by the recipient of the petty cash
 When the petty cash fund is almost depleted, the petty cash fund custodian will
get reimbursements
 This reimbursement will go through then check voucher system where the
custodian gets a check with the petty cash voucher as supporting documents
 The check must also be cross-checked by two lines on the payee section of the
check
 This cross-checking requires depositing of a check
 It cannot be encashed
 This make more difficult for somebody who stole a check to get the money
2. Accounts Receivable

 Providing credit terms to customers is one way of generating sales

 To prove this point, consider a real estate company which sells condominium
units at P5 million per unit. How many units can the property developer sell if he
sells the units only cash basis? Do you think he can sell a lot? Probably not as
many as compared to providing instalment payments
 Management of accounts receivable is important
 1. Character

2. Capacity

5 Cs of Credit 3. Capital

4. Collateral

5.Condition
Sources and Uses of
short-term and long-
term funds
Sources of
financing
 1. debt financing
 2. Equity financing
Equity Financing
Questions

1. Why is management of working capital important?

2. Enumerate the three working capital financing policies and describe each briefly
3. What are the Cs of credit
4. What are the advantages and disadvantages of debt financing
5. What are the advantages and disadvantages of equity financing