WORKING

CAPITAL
MANAGEMENT

WORKING CAPITAL
MANAGEMENT
(SHORT-TERM
FINANCIAL)
Management of current assets and current
liabilities to achieve a balance between
profitability and risk that contributes positively
to the firms value.

WORKING CAPITAL

Current assets, which represent the portion of

the investment that circulates from one form to
another in the ordinary conduct of business.

NET WORKING
CAPITAL
Difference between the firms current assets and
current liabilities.
Net Working Capital = Current Assets Current Liabilities

When current assets exceed current liabilities, the firm

has positive net working capital.
When current assets are less than current liabilities, the
firm has negative net working capital.
***The greater the margin by which a firms current
assets cover its current liabilities, the better it will
be able to pay its bills as they come due.

CASH CONVERSION
CYCLE

Length of time required for a company to convert

cash invested in its operations to cash received as
a result of its operation.

OPERATING CYCLE
(OC)

Time from the beginning of the production process

to collection of cash from the sale of the finished
product.
It encompasses two major short term asset
categories, INVENTORY and ACCOUNTS
RECEIVABLE.
It is measured in elapsed time by summing the
AVERAGE AGE OF INVENTORY (AAI) and the
AVERAGE COLLECTION PERIOD (ACP).

OC = AAI + ACP

where:
OC Operating
Cycle

CCC = OC APP

CCC- Cash
Conversion Cycle
AAI Average Age
of Inventory

CCC= AAI + ACP APP

ACP Average
Collection Period

Camp Manufacturing turns over its inventory eight

times each year, has an average payment period of 35
days, and has an average collection period of 60 days.
The firms annual sales are P3.5 million. Assume there
is no difference in the investment per peso of dales in
inventory, receivables, and payables and that there is a
365-day year.
a. Calculate the firms operating cycle and cash
conversion cycle.
b. Calculate the firms daily cash operating
expenditure. How much in resources must be
invested to support its cash conversion cycle.
c. If the firm pays 14% of these resources, by how
much would it increase its annual profits by
favorably changing its current cash conversion cycle
by 20 days?

INVENTORY
MANAGEMENT

The goal is to turn over inventory as quickly as

possible without stockouts.

TECHNIQUES FOR
MANAGING INVENTORY

ABC INVENTORY SYSTEM

Divides inventory into three groups A, B and C, in
descending order of importance and level of monitoring, on
the basis of the dollar investment in each.
ECONOMIC ORDER QUANTITY (EOQ) MODEL
Determining an items optimal order size, which is the
size that minimizes the total of its order costs ad carrying
costs.
ORDER COST fixed clerical costs of placing and
receiving an inventory order
CARRYING COST variable costs per unit of holding an
item in inventory for a specific period of time.
TOTAL COST OF INVENTORY sum of order costs and
carrying costs of inventory
REORDER POINT point at which to reorder inventory,
expressed as days of lead time * daily usage

ORDER COST = O * (S/Q)

where:
CARRYING COST = C * (Q/2)

TOTAL COST = [O * (S/Q)] + [C * (Q/2)]

EOQ =

S usage in units
per period
O order cost per
order
C carrying cost
per unit per period
Q order quantity
in units

The bakery uses an average of 4860 bags a year.

Preparing an order and receiving a shipment of flour
involves a cost of P10 per order. Annual carrying costs
are P75 per bag.
a.
b.
c.
d.

Determine the EOQ.

Determine the total annual cost.
How many times to reorder a year?
Determine the length of the order cycle (360 days
operations per year).
e. Determine the reorder point if the lead time is 8
days.

JUST-IN-TIME (JIT) SYSTEM

- Inventory management technique that minimizes
inventory investment by having materials arrive at exactly
the time they are needed for production.

MATERIALS REQUIREMENT PLANNING

(MRP) SYSTEM
- Inventory management technique that applies the EOQ
concepts and a computer to compare the production
needs to available inventory balances and determine
when orders should be placed for various items on a
products bill of materials.

MATERIALS REQUIREMENT PLANNING II

(MRP II) SYSTEM
- A sophisticated computerized system that integrates
data from numerous areas such as finance, accounting,
marketing, engineering, and manufacturing and
generates production plans as ell as numerous financial
and management reports.

ENTERPRISE RESOUCE PLANNING (ERP)

- A computerized system that electronically integrates
external information about the firms suppliers and
customers with the firms departmental data so that
information on all available resources human and
material can be instantly obtained in a fashion that
eliminates production delays and controls cost.

ACCOUNTS
RECEIVABLE
MANAGEMENT
AVERAGE COLLECTION PERIOD average length of time
from a sale on credit until the payment becomes usable funds for
the firm.
TWO PARTS:
1. Time from the sale until the customer mails the payment.
2. Time from when the payment is mailed until the firm has the
collected funds in its bank account.
The goal is to collect accounts receivable as quickly as possible
without losing sales from high pressure collection techniques.

Dodd Tool, a manufacturer of lathe tools, is currently

selling a product for P10 per unit. Sales (all on credit) for
last year were 60,000 units. The variable cost per unit is
P6. The firms total fixed costs are P120,000.
The firm is currently contemplating a relaxation of credit
standards that is expected to result in the following: a 5%
increase in unit sales to 63,000 units; an increase in the
average collection period from 30 days (current level) to
45 days; an increase in bad debt expenses from 1% of sale
(current level) to 2%. The firm determines that its cost of
typing up funds is receivable is 15% before taxes.
To determine whether to relax its credit standards, Dodd
Tool must calculate its effect on the firms additional
profit contribution from sales, the cost of the marginal
investment in accounts receivable, and the cost of
marginal bad debts.

MANAGEMENT OF
RECEIPTS AND
DISBURSEMENTS
TWO PARTS:
1. Time from the purchase of goods on account
until the firm mails its payment.
2. The receipt, processing, and collection
time required by the firms suppliers.

FLOAT
- Funds that have been sent by the payer but are not yet
usable funds to the payee.
MAIL FLOAT time delay between when payment is
placed in the mail and when it is received.
PROCESSING FLOAT time between receipt of a
payment and its deposit into the firms account
CLEARING FLOAT time between deposit of
payment and when spendable funds become available to
the firm.
LOCKBOX SYSTEM
- A collection procedure in which customers mail
payments to a post office box that is emptied regularly by
the firms bank, which processes the payments and
deposits them in the firms account. This system speeds
up collection time by reducing processing time as well as
mail and clearing time.

CONTROLLED DISBURSING
- Strategic use of mailing points and bank
accounts to lengthen mail float and clearing
float, respectively,

CASH CONCENTRATION
- Process used by the firm to bring lockbox and
other deposits together into one bank, often
called the concentration bank.

DEPOSITORY TRANSFER CHECK(DTC)

- Unsigned check drawn on one of a firms
bank accounts and deposited in another.

ACH (AUTOMATED CLEARINGHOUSE) TRANSFER

- Preauthorized electronic withdrawal from the payers
account and deposit into the payees account via a
settlement among banks by the ACH.

WIRE TRANSFER
- An electronic communication that, via bookkeeping
entries, removes funds from the payers bank and deposits
them in the payees bank.
ZERO BALANCE ACCOUNT (ZBA)
- Disbursement account that always has an end of day
balance of zero because the firm deposits money to cover
checks drawn on the account only as they are presented for
payment each day.