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Chapter 6 :

Working Capital

Working capital is a portion of the total capital of the

firm that is continually circulating.

Gross Working Capital (total current assets)
Net Working Capital (total current assets minus current

Needed to:

(1)Replenish of Inventory (3)Support for credit sales

(2) Provision for Operating (4)Provision of safety margin
A working capital must;

Adequate to cover all current financial

Liquid enough to meet current obligations
Conserved through proper allocation & economical
Used in attainment of the profit objectives
Management of Working Capital

Concerned with the problems that arise in

attempting to manage the CA, CL and the inter-

relationship that exists between them.

Working capital needs careful management.

Liquidity Management
Activities geared towards achieving the liquidity
objectives of the firm.
-to acquire sufficient amounts of funds to
cover cash requirements of firm.
Cash Sales The percentage of cash derived from sales vary
from company to company and from industry to industry.

Collection of Accounts Receivables The credit policies and

the pattern of company sales determine the frequency and
volume of collections from receivables

Loans is the lending of money from one individual,

organization or entity to another individual, organization or
Sales of Assets Assets are sometimes sold by the company
for various reasons.

Ownership Contribution Additional contributions from the

owners are sometimes tapped to improve the liquidity
postures of the firm.

Advances from Customers Manufacturers requires cash

advances from customer as soon as an order is made and
before production is started.
Cash Management

Money Mobilization involves techniques used to assemble funds and

make them readily available for investment

Effective Cash Flow Provides firm with realistic approaches to

planning and budgeting

Liquidify reserve To avoid unnecessary losses or expenditures

definition and brought by liquidating problems

Productive use of Cash surplus may be utilized by firm to earn

Surplus Assets higher returns. Planning activities must also be
geared towards eliminating the less productive
Accounts Receivable Management

Determine Cost and There is not point in extending credit to

Profitability of customers if this will cause a lowering of
Credit Sales firms return on investment.

Projection of Cash Provides an essential input in the

Flows from preparation of firms financial plan.

Is the system used by a business to make sure

Direction and that it gives credit only to customers who are
Control of Credit able to pay, and that customers pay on time.
Elements of the Cost of Credit The cost credit is composed
of three elements (1) bad debts (2) cost of invested funds; and
(3) administrative costs.

Sources of Credit Information A variety of sources may be

used to obtain credit information concerning customers.

Evaluation of Credit Risk Before credit is granted, the risk

involved is evaluated.

Capital refers to the financial resources of the credit


Capacity refers to the ability of the applicant to

operate successfully
Character refers to the reputation for honesty and
fair dealing of the applicant.

Conditions refers to the environment required for

the extension of credit.
Inventory Management

To cut costs and boost efficiency and


Customer Service
Objective is to
strike a balance Inventory Investment
Profit Aspects

EOQ Economic Order Quantity method is used to

determine what quantity to order so as to minimize
total inventory costs.

EOQ= the square root of 2 US/CI

EOQ = economic order quantity EOQ = 2(U)(S)
U = annual usage
S = Ordering cost
C = Cost per unit
I = annual carrying cost