Working Capital Management

1. WORKING CAPITAL
MANAGEMENT

2. OUTLINE
• Characteristics of Current Assets
• Factors Influencing Working Capital Requirements
• Level of Current Assets
• Current Assets Financing Policy
• Profit Criterion for Current Assets
• Operating Cycle Analysis
• Cash Requirement for Working Capital

3. CHARACTERISTICS OF CURRENT ASSETS
• Short life span
• Swift transformation into other asset forms
Current Assets Cycle
Accounts
receivable
Finished
goods
Wages, salaries,
factory overheads
Work-in-
process
Raw materials
Cash Suppliers

4. FACTORS INFLUENCING WORKING
CAPITAL REQUIREMENTS
• Nature of Business
• Seasonality of Operations
• Production Policy
• Market Conditions
• Conditions of Supply

5. WORKING CAPITAL POLICY
Two important issues in working capital policy are:
• What should be the level of investment in current
assets?
• What mix of long-term and short-term financing should
the firm employ to support current assets?

6. LEVEL OF CURRENT ASSETS
Flexible Restrictive
(Conservative) (Aggressive)
Policy Policy
Liquidity High Low
Inventories Large Small
Debtors High Low
A flexible policy results in fewer production stoppages, ensures
quicker deliveries to customers, and stimulates sales .. but
HIGHER INVESTMENT IN CURRENT ASSETS
A restrictive policy leads to more production stoppages, delayed
deliveries to customers, and lost sales … but
LOWER INVESTMENT IN CURRENT ASSETS

7. CAPITAL REQUIREMENTS
AND THEIR FINANCING
Capital
requirements
Fluctuating current
asset requirement
Permanent current
asset-requirement
Fixed asset
requirement
Time
A
B
C

8. CURRENT ASSETS FINANCING
POLICY
According to the matching principle, fixed assets and
permanent current assets should be supported by long-
term sources of finance whereas fluctuating current assets
must be supported by short-term sources of finance.

9. PROFIT CRITERION FOR
WORKING CAPITAL
• Investment in current assets is easily reversible.
• For reversible investments, the criterion of net profit per
period (which here means residual income) is equivalent
to the criterion of net present value

10. OPERATING CYCLE AND CASH CYCLE
Order placed Stock arrives Goods sold Cash received
Inventory period Accounts
receivable period
Accounts
payable period
Firm receives Cash paid for
invoice materials
Operating cycle
Cash cycle
Average inventory
Inventory period =
Average COGS / 365
Average accounts receivable
Accounts receivable period =
Annual sales / 365
Average accounts payable
Average payable period =
Average COGS / 365

11. ILLUSTRATION
Financial Information for Horizon Limited
Balance Sheet Data
Profit and Loss Beginning of End of
Account Data 20X0 20X0
Sales 800 Inventory 96 102
Cost of goods 720 Accounts receivable 86 90
Sold Accounts payable 56 60
(96 + 102) / 2
Inventory period = = 50.1 days
720 / 365

12. (86 + 90) / 2
Accounts receivable period = = 40.2 days
800 / 365
(56 + 60) / 2
Accounts payable period = = 29.4 days
720 / 365
Operating cycle = 50.1 + 40.2 = 90.3 days
Inventory Accounts
period receivable
period
Cash cycle = 90.3 - 29.4 = 60.9 days
Operating Accounts
cycle payable period

13. CASH REQUIREMENT FOR
WORKING CAPITAL
Step 1 : Estimate the cash cost of various current assets
required by the firm.
Step 2 : Deduct the spontaneous current liabilities from
the cash cost of current assets