FINANCIAL PLANNING AND TOOLS

Objectives: CONCEPT
- I will be able to understand working capital
management, net working capital, and the
related trade-off between profitability and
risk.
- I will be able to describe the cash
conversion cycle, its funding requirements,
and the key strategies for managing it.
Working Capital – refers to the company’s investment in
current assets such as cash, accounts receivable, and
inventories.
Net Working capital- refers to the difference between
current assets and current liabilities.
Operating cycle
– refers to the
sum of days of
inventory and
days of
receivables
Days of Inventory or inventory
conversion period or average age of
inventories
- is the average number of days to sell
its inventory.
- A DSI of 20 days means that on the average it
takes 20 days to sell its inventory. The formula
is:
- Since the Statement of Financial Position tells
the financial condition of a company at the end
of the period, we take Average Inventory for the
year in our calculation.
DOI =365 or (360) days
Inventory Turnover
Or
DOI = Average Inventory/Average
COGS per day
ITO = COGS/Beg Inv + Ending Inv/2
 DAY OF SALES OUTSTANDING
- It is the average time for the
company to collect its receivables.
- For example, a DSO of 40 days means that a
customer who purchased on the company on
account will pay his/her balance in 40 days.
- The formula is:
DSO = 365 or (360) days
Receivable turnover
Receivable turnover = net credit sales
Beg A/R + Ending A/R
2
 CASH CONVERSION CYCLE
- also called the net operating cycle, is computed
as the operating cycle less days of payable.
- In formula form:
Cash Conversion Cycle = Operating Cycle - Days of
Payables
Cash Conversion Cycle = (Days of Inventory + Days
of Receivables) - Days of Payables
 DAYS OF PAYABLES OUTSTANDING (DPO)
- is the average number of days for the
company to pay its creditors
- A DPO of 30 days means that the
company waits for 30 days before
paying its creditors.
 DPO FORMULA
Days of inventory = 365 or (360)days
Payable turnover
Payables turnover = Net credit purchases
Beg payables + Ending payables
2
Formula Numerator Denominator

Inventory Cost of goods Average

turnover inventory
Receivables Net credit Average
turnover sales receivables
Payables Net credit Average
turnover purchases payables
Using the above figures, the CCC will be:
DSI = 20 DSO = 40 DPI = 30
CCC = 20 + 40 – 30 = 30
30 days is the time between the cash outlay and
the cash received.
If the CCC is negative, it indicates that the
company has excess cash to invest. A CC of -10
indicates that the company has excess cash to
invest for 10 days.
 WORKING CAPITAL MANAGEMENT
The primary objective is to achieve a balance
between profitability and risk. Basically, there are
three types of working capital financing policies the
management can choose from:
1. Maturity-matching working capital financing
policy
2. Aggressive working capital financing policy
3. Conservative working capital financing policy
 DEEPENING QUESTION:
A company needs PHP10 million in
working capital to support an annual sales
of PHP50 million. If the sales increase to
PHP100 million, will the PHP10 million
working capital be enough?
Permanent Working Capital
- is the minimum level of current assets required by a
firm to carry-on its business operations given its
production capacity or relevant sales range.
Temporary working capital
- is the excess of working capital over the permanent
working capital given its production capacity or
relevant sales range.
Bugay is managing the working capital of SR Ice
Cream. SR Ice Cream is engaged in the selling of
different ice creams. The following are the sales
volume, and the working capital needed based on
the recent years:
- We can see that the working capital never
goes below P120,000. That is the
permanent working capital requirement.
- The maximum temporary working capital is
P180,000 (difference between the P300,000
working capital and the permanent working
capital of P120,000) at the peak season with
P900,000 sales level.
- For the 4th Quarter, the temporary
working capital is P30,000 (difference
between the PHP150,000 working
capital and the permanent working
capital of PHP120,000).
 MATURITY-MATCHING WORKING CAPITAL
FINANCING 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.
 MATURITY-MATCHING WORKING CAPITAL
FINANCING POLICY
- Long-term sources of financing include long-
term debt and equity such as common stock
and preferred stock. Short-term sources
include short-term loans from a bank.
 These short-term loans from banks are
called working capital loans which
perfectly describe the reasons why these
loans are incurred.
- All permanent working capital must be
financed by long-term sources while
temporary working capital requirements
should be financed by short-term sources
 AGGRESSIVE WORKING CAPITAL
FINANCING POLICY
- Some of the permanent working capital
requirements are financed by short-term
sources of financing.
 CONSERVATIVE WORKING CAPITAL
FINANCING POLICY
- Even some of the temporary working
capital requirements are financed by
long-term sources of financing.
- It minimizes liquidity risk but it also
reduces the company’s profitability
because long-term sources of financing
entail higher cost.
 PRACTICE :
Philippine products company is concerned about
managing cash efficiently. On the average,
inventories have an age of 90days and accounts
receivable are collected in 60days. Accounts
payable are paid approximately 30days after they
arise. The firm has annual sales of about
P30million. Assume there is no difference in the
investment per peso of sales in inventory,
receivables and payables that there is 360-day year.
 ANSWER THE FOLLOWING:
1. Compute the firm’s operating cycle
2. Compute for the firm’s cash
conversion cycle.
3. Discuss how management might be
able to reduce the cash conversion
cycle
 ACTIVITY:
Cross-examine the statements of the
financial position of Jollibee Food
Corporation and answer the following
questions below.
ACTIVITY:
Questions:
1. What are the assets needed by
Jollibee Food Corporation for its
daily operation?
2. Compute. How much is the Net
Working Capital of Jollibee Food
Corporation?
Pam has a small restaurant business with
current equity of PHP60,000. With the
increasing demand, she is planning to expand
her restaurant space. After much analysis she
determined that an initial investment of
PHP50,000 in fixed assets is necessary.
The first is the no-debt plan, under which she
would ask a relative to become an investor (Owner)
by investing the full PHP50,000. The other
alternative, the debt plan, involves borrowing
PHP50,000 from the nearby rural bank at 10%
annual interest.
DISTINGUISH DEBT AND EQUITY
FINANCING
Pam has a small restaurant business with current equity of
PHP60,000. With the increasing demand, she is planning to expand
her restaurant space. After much analysis she determined that an
initial investment of PHP50,000 in fixed assets is necessary. These
funds can be obtained in either of two ways. The first is the no-
debt plan, under which she would ask a relative to become an
investor (owner) by investing the full PHP50,000. The other
alternative, the debt plan, involves borrowing PHP50,000 from the
nearby rural bank at 10% annual interest.
 FINANCING
is the process of providing funds for business activities, making
purchases, or investing.

TWO TYPES OF FINANCING

a. Debt financing
b. Equity financing
 DEBT FINANCING
involves borrowing funds from creditors either short-term or
long-term with interest at a specified future of time.
a. Bank loans - are the first tool to consider in the context of
corporate debt. Bank loans usually require some type of collateral,
an asset that the bank can confiscate and sell if the borrower fails to
make the payments.
b. Bonds - are financial instruments that promise a specific periodic
payment to the owner of the bond. Interest rates on bonds are
generally lower than bank loans.
c. • Lending companies and Cooperatives - are financing from non-
bank institutions.
 EQUITY FINANCING
is a method of raising capital by selling company stock to
investors (stockholders) in exchange for ownership interests in the
company.
a. Shares - when a company sells shares to other investors, it gives up
a piece of itself as a way to raise money finance growth.
b. Venture capital - is a form of private equity and a type of financing
that investors provide to start-up companies and small businesses
that are believed to have long-term growth potential.
c. Taking on a partner - is one oldest forms of equity financing.
Looking for partnerships to chip in, they will have equity in the
business and became a part’ owner
 ADVANTAGES
Debt Financing
- The bank can’t tell how to run the
business. The owner maintains the full
ownership.
- After paying the loan off, you have no
obligations to the bank.
- Interest on the loan is tax’ deductible.
- You can get a short-term or long-term
loan.
- You know what the principal and interest
cost, so you can create a business
budget.
Equity Financing
- You have less risk than you would
with a loan.
- You don’t pay the funds back.
- Your investor’s network could help
your business gain credibility.
- Investors don’t expect to see an
immediate return on investment
(ROI).
- You have more cash on hand
without repayments.
 DISADVANTAGES
Debt Financing Equity Financing
- You have to pay back the loan within a - The returns you pay an investor
designated period. could be more than bank loan
- Debt financing could cause small repayments.
business cash flow problems. - The investor requires some
- You will probably need to offer ownership of your business.
business collateral. - You need to consult the investor
before making business decisions
- Long-term finance - any financial instrument with a maturity
exceeding one year (such as bank loans, bonds, leasing, and other
forms of debt finance), and public and private equity instruments.

- Short-term finance - refers to financing needs for a small period

normally less than a year. This type of financing is normally needed
because of the uneven flow of cash in the business, the seasonal
pattern of business, etc. In most cases, it is used to finance all types
of inventory, accounts receivables, etc.