WORKING CAPITAL

MANAGEMENT
FUNDAMENTALS

Working capital management

- involves both setting working

capital policy and carrying out
that policy in day-to-day
operations.
Working capital
- refers to current assets used in
operations.
Working capital policy
- refers to the firms policies
1. target levels for each category of
current
assets assets will be
2. how current
financed.

Net working capital

Net working Capital = Current
assets Current
liabilities
Net operating working capital
- is defined as current assets
minus noninterest-bearing current
liabilities.

Cash Conversion Cycle Model

- Focuses on the length of time
between when the company makes
payments and when it receives cash
inflows.

The following terms are used in

the model:

Inventory conversion period

Receivables collection period
Payables deferral period

Inventory conversion period

is the average time required to convert
materials into finished goods and then to sell
those goods.
Example, if average inventories are $2 million
and sales are $10 million, then the inventory
conversion period is?

Inventory conversion period =

Inventory
Sales per day

= $2,000,000
$10,000,000/365
=73 days

eceivables collection period

- is the average length of time required to
convert the firms receivables into cash, that is,
to collect cash following a sale.
Example: If receivables are $657,534 and sales
are $10 million, the receivables collection period
is
Receivables collection period =
DSO= Receivables
Sales/365
=
$657,534
$10,000,000/365
=24 days

Payables deferral period

is the average length of time between the
purchase of materials and labor and the
payment of cash for them.
Example: if its cost of goods sold are $8 million per
year, and if its accounts payable average $657,534
Payables deferral period =
Payables
Cost of good sold/365
= $657,534
$8,000,000/365
= 30 days

Cash conversion cycle

- is equals the length of time
between the firms actual cash
expenditures to pay for productive
resources (materials and labor) and
its own cash receipts from the sale
of the products.
Cash
Inventory Receiva Payable
conversi conversio bles
s
on cycle n period collectio deferra
n period l period

Components of Working Capital

Cash
Marketable Securities
Inventory
Accounts Receivable

Goal of Cash Management

-is to reduce the amount of cash held to the
minimum necessary to conduct business.
REASONS FOR HOLDING
CASH
Transactions Balance
A cash balance associated with payments
and collections; the balance necessary for
day-to-day operations
Compensating Balance
A bank balance that a firm must
maintain to compensate the bank for
services rendered or for granting a loan.

Marketable Securities
- Securities that can be sold on short notice.
Goals of inventory management
to ensure that the inventories needed to sustain
operations are available
to hold the costs of ordering and carrying
inventories to the lowest possible level
Inventory
can be group as:
supplies
raw materials

work-in process
finished goods

ACCUMULATION OF
The total amount of accounts receivable outstanding
RECEIVABLES
at any given time is determined by two factors:

1. the volume of credit sales

2. the average length of time between sales and
collections

EXAMPLE: Boston Lumber Company (BLC), a wholesale

distributor of lumber products, opens a warehouse on January 1
and, starting the first day, makes sales of $1,000 each day. For
simplicity, we assume that all sales are on credit, and customers
are given 10 days to pay.

Account
s
receiva
ble

Credi
t
sales
per
$
day
1,000

$ 10,000

Length
of
collecti
on
10
period
days

Days Sales Outstanding (DSO)

- The average length of time required to collect
credit sales.

Aging Schedule

A report showing how long accounts

receivable have been outstanding.

CREDIT
POLICY
- A set of decisions that include a firms credit period,
credit standards, collection procedures, and discounts
offered.
Credit period
- which is the length of time buyers are given to pay for their
purchases.
Discounts
- given for early payment, including the discount percentage
and how rapidly payment must be made to qualify for the
discount.
Credit standards
-which refer to the required financial strength of acceptable
credit customers.
Collection policy
- which is measured by its toughness or laxity in
attempting to collect on slow-paying accounts.

Short-term credit
is defined as any liability originally
scheduled for payment within one
Theyear.
four major sources of shortterm credit:
Accrual
Accounts payable

Loans from commercial banks and finance

companies
Commercial paper