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Presented By: 
Yaser Ali Hassan 
Awais Sharif 
Kamar Farooq 
Nadeem Nazir
Working Capital & 
Current Asset 
Management
Net Working Capital 
 Working Capital includes a firm’s current 
assets, which consist of cash and marketable 
securities in addition to accounts receivable 
and inventories. 
 It also consists of current liabilities, including 
accounts payable (trade credit), notes payable 
(bank loans), and accrued liabilities. 
 Net Working Capital is defined as total current 
assets less total current liabilities.
The Cash Conversion Cycle 
 Short-term financial management—managing current assets 
and current liabilities is one of the financial manager’s most 
important and time-consuming activities. 
 Central to short-term financial management is an 
understanding of the firm’s cash conversion cycle.
Cash Conversion Cycle 
Inventory turnover ratio (IT): 
3.56 
IT = Cost of Goods = 131,924 
= 
37,009 
Inventory 
102 days 
Inventory Days = 365 = 365 
= 
3.56 
IT
Cash Conversion Cycle 
 Accounts receivable turnover (ART): 
9.05 
ART = Sales = 169,565 
= 
18,735 
Acct. Rec. 
40 days 
Average Collection Period = 365 = 365 
= 
9.05 
ART
Cash Conversion Cycle 
 Accounts payable turnover (APT): 
24.22 
APT = Cost of Goods = 131,924 
= 
5,448 
Accts. Payable 
15 days 
Average Payment Period = 365 = 365 
= 
24.22 
APT
Calculating the Cash Conversion 
Cycle 
 Both the OC and CCC may be computed 
as shown below. 
OC = Inventory Days + ACP 
 OC = 102 + 40 = 142 days 
CCC = OC – Average Payment Period 
 CCC = 142 – 15 = 127 days
Cash Conversion Cycle 
Chromcraft Revington’s Operating Cycle 
Average Collection 
Average Age of Inventory (AAI) Period (ACP) 
Days 0 102 142
Problem # 1 
American Products is concerned about managing cash efficiently. On the 
average , inventories have an age of 90 days and account receivable are 
collected in 60 days . Accounts payable are paid approximately 30 days after 
they arise. 
 Operating cycle (OC) = Average age of inventories + Average collection period 
= 90 days + 60 days 
= 150 days 
 Cash Conversion Cycle (CCC) = Operating cycle − Average payment period 
= 150 days − 30 days 
= 120 days
Funding Requirements of the 
CCC 
 Permanent vs. Seasonal Funding Needs 
 If a firm’s sales are constant, then its investment 
in operating assets should also be constant, 
and the firm will have only a permanent 
funding requirement. 
 If sales are cyclical, then investment in operating 
assets will vary over time, leading to the need for 
seasonal funding requirements in addition to the 
permanent funding requirements for its minimum 
investment in operating assets.
Strategies for Managing the 
CCC 
1. Turn over inventory as quickly as possible 
without stock outs that result in lost sales. 
2. Collect accounts receivable as quickly as 
possible without losing sales from high-pressure 
collection techniques. 
3. Manage, mail, processing, and clearing time to 
reduce them when collecting from customers 
and to increase them when paying suppliers. 
4. Pay accounts payable as slowly as possible 
without damaging the firm’s credit rating.
Inventory Management: 
Inventory Fundamentals 
 Classification of inventories: 
Raw materials: items purchased for use in 
the manufacture of a finished product 
Work-in-progress: all items that are currently 
in production 
Finished goods: items that have been 
produced but not yet sold
Inventory Management: 
Differing Views About Inventory 
 The different departments within a firm (finance, 
production, marketing, etc.) often have differing views 
about what is an “appropriate” level of inventory. 
 Financial managers would like to keep inventory levels 
low to ensure that funds are wisely invested. 
 Marketing managers would like to keep inventory levels 
high to ensure orders could be quickly filled. 
 Manufacturing managers would like to keep raw 
materials levels high to avoid production delays and to 
make larger, more economical production runs.
Techniques for Managing 
Inventory 
 The ABC System 
 The ABC system of inventory management divides 
inventory into three groups of descending order of 
importance based on the dollar amount invested 
in each. 
 A typical system would contain, group A would 
consist of 20% of the items worth 80% of the total 
dollar value; group B would consist of the next largest 
investment, and so on. 
 Control of the A items would intensive because of the 
high dollar investment involved.
Techniques for Managing 
Inventory (cont.) 
 The Economic Order Quantity (EOQ) Model 
EOQ = 2 x S x O 
C 
 Where: 
 S = usage in units per period (year) 
 O = order cost per order 
 C = carrying costs per unit per period (year) 
 Q = order quantity in units
Techniques for Managing 
Inventory (cont.) 
 The Economic Order Quantity (EOQ) Model 
Assume that KJB, Inc. uses 200 units of an item annually. Its 
order cost is $25 per order, and the carrying cost is $1 per unit 
per year. Substituting into the above equation we get: 
EOQ = 2(200)($25) = 100 
$1 
The EOQ can be used to evaluate the total cost of inventory 
as shown on the following slides.
Techniques for Managing 
Inventory (cont.) 
 The Economic Order Quantity (EOQ) Model 
Ordering Costs = Cost/Order x # of Orders/Year 
Ordering Costs = $25 x 2 = $50 
Carrying Costs = Carrying Costs/Year x Order Size 
2 
Carrying Costs = ($1 x 100)/2 = $50 
Total Costs = Ordering Costs + Carrying Costs 
Total Costs = $50 + $50 = $100
Techniques for Managing 
Inventory (cont.) 
 The Reorder Point 
 Once a company has calculated its EOQ, it must 
determine when it should place its orders. 
 More specifically, the reorder point must consider 
the lead time needed to place and receive orders. 
 If we assume that inventory is used at a constant rate 
throughout the year (no seasonality), the reorder point 
can be determined by using the 
following equation: 
Reorder point = lead time in days x daily usage 
Daily usage = Annual usage/360
Techniques for Managing 
Inventory (cont.) 
Using the KJB example above, if they know that it requires 5 days to 
place and receive an order, and the annual usage is 200 units per 
year, the reorder point can be determined as follows: 
Daily usage = 200/360 = 0.56 units/day 
Reorder point = 5 x 0.56 = 2.78 or 3 units 
Thus, when RIB’s inventory level reaches 3 units, it should place an 
order for 100 units. However, if RIB wishes to maintain safety stock 
to protect against stock outs, they would order before inventory 
reached 3 units.
Techniques for Managing 
Inventory (cont.) 
 Just-In-Time (JIT) System 
 The JIT inventory management system minimizes 
the inventory investment by having material inputs 
arrive exactly at the time they are needed 
for production. 
 For a JIT system to work, extensive coordination must 
exist between the firm, its suppliers, and shipping 
companies to ensure that material inputs arrive on 
time. 
 In addition, the inputs must be of near perfect quality 
and consistency given the absence of safety stock.
Techniques for Managing 
Inventory (cont.) 
 Computerized Systems for 
Resource Control 
MRP systems are used to determine what to 
order, when to order, and what priorities to 
assign to ordering materials. 
MRP uses EOQ concepts to determine how 
much to order using computer software. 
It simulates each product’s bill of materials 
structure all of the product’s parts), inventory 
status, and manufacturing process.
Accounts Receivable 
Management 
 The second component of the cash conversion 
cycle is the average collection period – the 
average length of time from a sale on credit until 
the payment becomes usable funds to the firm. 
 The collection period consists of two parts: 
 the time period from the sale until the customer mails 
payment, and 
 the time from when the payment is mailed until the 
firm collects funds in its bank account.
Accounts Receivable Management: 
The Five Cs of Credit 
 Character: The applicant’s record of meeting 
past obligations. 
 Capacity: The applicant’s ability to repay the 
requested credit. 
 Capital: The applicant’s debt relative to equity. 
 Collateral: The amount of assets the applicant 
has available for use in securing the credit. 
 Conditions: Current general and industry-specific 
economic conditions.
Accounts Receivable Management: 
Credit Scoring 
 Credit scoring is a procedure resulting in a 
score that measures an applicant’s overall credit 
strength, derived as a weighted-average of 
scores of various credit characteristics. 
 The procedure results in a score that measures 
the applicant’s overall credit strength, and the 
score is used to make the accept/reject decision 
for granting the applicant credit.
Accounts Receivable Management: 
Changing Credit Standards 
 The firm sometimes will contemplate changing 
its credit standards to improve its returns and 
generate greater value for its owners.
Changing Credit Terms 
 A firm’s credit terms specify the repayment 
terms required of all of its credit customers. 
 Credit terms are composed of three parts: 
 The cash discount 
 The cash discount period 
 The credit period 
 For example, with credit terms of 2/10 net 30, 
the discount is 2%, the discount period is 10 
days, and the credit period is 30 days.
Credit Monitoring 
 Credit monitoring is the ongoing review of a 
firm’s accounts receivable to determine whether 
customers are paying according to the stated 
credit terms. 
 Slow payments are costly to a firm because 
they lengthen the average collection period 
and increase the firm’s investment in 
accounts receivable. 
 Two frequently used techniques for credit 
monitoring are the average collection period and 
aging of accounts receivable.
Credit Monitoring: 
Average Collection Period 
 The average collection period is the average 
number of days that credit sales are outstanding 
and has two parts: 
 The time from sale until the customer places the 
payment in the mail, and 
 The time to receive, process, and collect payment.
Credit Monitoring: 
Collection Policy 
 The firm’s collection policy is its 
procedures for collecting a firm’s accounts 
receivable when they are due. 
 The effectiveness of this policy can be 
partly evaluated by evaluating at the level 
of bad expenses. 
 As seen in the previous examples, this 
level depends not only on collection policy 
but also on the firm’s credit policy.
Collection Policy
Cash conversion cycle

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Cash conversion cycle

  • 1.
  • 2. Presented By: Yaser Ali Hassan Awais Sharif Kamar Farooq Nadeem Nazir
  • 3. Working Capital & Current Asset Management
  • 4. Net Working Capital  Working Capital includes a firm’s current assets, which consist of cash and marketable securities in addition to accounts receivable and inventories.  It also consists of current liabilities, including accounts payable (trade credit), notes payable (bank loans), and accrued liabilities.  Net Working Capital is defined as total current assets less total current liabilities.
  • 5. The Cash Conversion Cycle  Short-term financial management—managing current assets and current liabilities is one of the financial manager’s most important and time-consuming activities.  Central to short-term financial management is an understanding of the firm’s cash conversion cycle.
  • 6. Cash Conversion Cycle Inventory turnover ratio (IT): 3.56 IT = Cost of Goods = 131,924 = 37,009 Inventory 102 days Inventory Days = 365 = 365 = 3.56 IT
  • 7. Cash Conversion Cycle  Accounts receivable turnover (ART): 9.05 ART = Sales = 169,565 = 18,735 Acct. Rec. 40 days Average Collection Period = 365 = 365 = 9.05 ART
  • 8. Cash Conversion Cycle  Accounts payable turnover (APT): 24.22 APT = Cost of Goods = 131,924 = 5,448 Accts. Payable 15 days Average Payment Period = 365 = 365 = 24.22 APT
  • 9. Calculating the Cash Conversion Cycle  Both the OC and CCC may be computed as shown below. OC = Inventory Days + ACP  OC = 102 + 40 = 142 days CCC = OC – Average Payment Period  CCC = 142 – 15 = 127 days
  • 10. Cash Conversion Cycle Chromcraft Revington’s Operating Cycle Average Collection Average Age of Inventory (AAI) Period (ACP) Days 0 102 142
  • 11. Problem # 1 American Products is concerned about managing cash efficiently. On the average , inventories have an age of 90 days and account receivable are collected in 60 days . Accounts payable are paid approximately 30 days after they arise.  Operating cycle (OC) = Average age of inventories + Average collection period = 90 days + 60 days = 150 days  Cash Conversion Cycle (CCC) = Operating cycle − Average payment period = 150 days − 30 days = 120 days
  • 12. Funding Requirements of the CCC  Permanent vs. Seasonal Funding Needs  If a firm’s sales are constant, then its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement.  If sales are cyclical, then investment in operating assets will vary over time, leading to the need for seasonal funding requirements in addition to the permanent funding requirements for its minimum investment in operating assets.
  • 13. Strategies for Managing the CCC 1. Turn over inventory as quickly as possible without stock outs that result in lost sales. 2. Collect accounts receivable as quickly as possible without losing sales from high-pressure collection techniques. 3. Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers. 4. Pay accounts payable as slowly as possible without damaging the firm’s credit rating.
  • 14. Inventory Management: Inventory Fundamentals  Classification of inventories: Raw materials: items purchased for use in the manufacture of a finished product Work-in-progress: all items that are currently in production Finished goods: items that have been produced but not yet sold
  • 15. Inventory Management: Differing Views About Inventory  The different departments within a firm (finance, production, marketing, etc.) often have differing views about what is an “appropriate” level of inventory.  Financial managers would like to keep inventory levels low to ensure that funds are wisely invested.  Marketing managers would like to keep inventory levels high to ensure orders could be quickly filled.  Manufacturing managers would like to keep raw materials levels high to avoid production delays and to make larger, more economical production runs.
  • 16. Techniques for Managing Inventory  The ABC System  The ABC system of inventory management divides inventory into three groups of descending order of importance based on the dollar amount invested in each.  A typical system would contain, group A would consist of 20% of the items worth 80% of the total dollar value; group B would consist of the next largest investment, and so on.  Control of the A items would intensive because of the high dollar investment involved.
  • 17. Techniques for Managing Inventory (cont.)  The Economic Order Quantity (EOQ) Model EOQ = 2 x S x O C  Where:  S = usage in units per period (year)  O = order cost per order  C = carrying costs per unit per period (year)  Q = order quantity in units
  • 18. Techniques for Managing Inventory (cont.)  The Economic Order Quantity (EOQ) Model Assume that KJB, Inc. uses 200 units of an item annually. Its order cost is $25 per order, and the carrying cost is $1 per unit per year. Substituting into the above equation we get: EOQ = 2(200)($25) = 100 $1 The EOQ can be used to evaluate the total cost of inventory as shown on the following slides.
  • 19. Techniques for Managing Inventory (cont.)  The Economic Order Quantity (EOQ) Model Ordering Costs = Cost/Order x # of Orders/Year Ordering Costs = $25 x 2 = $50 Carrying Costs = Carrying Costs/Year x Order Size 2 Carrying Costs = ($1 x 100)/2 = $50 Total Costs = Ordering Costs + Carrying Costs Total Costs = $50 + $50 = $100
  • 20. Techniques for Managing Inventory (cont.)  The Reorder Point  Once a company has calculated its EOQ, it must determine when it should place its orders.  More specifically, the reorder point must consider the lead time needed to place and receive orders.  If we assume that inventory is used at a constant rate throughout the year (no seasonality), the reorder point can be determined by using the following equation: Reorder point = lead time in days x daily usage Daily usage = Annual usage/360
  • 21. Techniques for Managing Inventory (cont.) Using the KJB example above, if they know that it requires 5 days to place and receive an order, and the annual usage is 200 units per year, the reorder point can be determined as follows: Daily usage = 200/360 = 0.56 units/day Reorder point = 5 x 0.56 = 2.78 or 3 units Thus, when RIB’s inventory level reaches 3 units, it should place an order for 100 units. However, if RIB wishes to maintain safety stock to protect against stock outs, they would order before inventory reached 3 units.
  • 22. Techniques for Managing Inventory (cont.)  Just-In-Time (JIT) System  The JIT inventory management system minimizes the inventory investment by having material inputs arrive exactly at the time they are needed for production.  For a JIT system to work, extensive coordination must exist between the firm, its suppliers, and shipping companies to ensure that material inputs arrive on time.  In addition, the inputs must be of near perfect quality and consistency given the absence of safety stock.
  • 23. Techniques for Managing Inventory (cont.)  Computerized Systems for Resource Control MRP systems are used to determine what to order, when to order, and what priorities to assign to ordering materials. MRP uses EOQ concepts to determine how much to order using computer software. It simulates each product’s bill of materials structure all of the product’s parts), inventory status, and manufacturing process.
  • 24. Accounts Receivable Management  The second component of the cash conversion cycle is the average collection period – the average length of time from a sale on credit until the payment becomes usable funds to the firm.  The collection period consists of two parts:  the time period from the sale until the customer mails payment, and  the time from when the payment is mailed until the firm collects funds in its bank account.
  • 25. Accounts Receivable Management: The Five Cs of Credit  Character: The applicant’s record of meeting past obligations.  Capacity: The applicant’s ability to repay the requested credit.  Capital: The applicant’s debt relative to equity.  Collateral: The amount of assets the applicant has available for use in securing the credit.  Conditions: Current general and industry-specific economic conditions.
  • 26. Accounts Receivable Management: Credit Scoring  Credit scoring is a procedure resulting in a score that measures an applicant’s overall credit strength, derived as a weighted-average of scores of various credit characteristics.  The procedure results in a score that measures the applicant’s overall credit strength, and the score is used to make the accept/reject decision for granting the applicant credit.
  • 27. Accounts Receivable Management: Changing Credit Standards  The firm sometimes will contemplate changing its credit standards to improve its returns and generate greater value for its owners.
  • 28. Changing Credit Terms  A firm’s credit terms specify the repayment terms required of all of its credit customers.  Credit terms are composed of three parts:  The cash discount  The cash discount period  The credit period  For example, with credit terms of 2/10 net 30, the discount is 2%, the discount period is 10 days, and the credit period is 30 days.
  • 29. Credit Monitoring  Credit monitoring is the ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms.  Slow payments are costly to a firm because they lengthen the average collection period and increase the firm’s investment in accounts receivable.  Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable.
  • 30. Credit Monitoring: Average Collection Period  The average collection period is the average number of days that credit sales are outstanding and has two parts:  The time from sale until the customer places the payment in the mail, and  The time to receive, process, and collect payment.
  • 31. Credit Monitoring: Collection Policy  The firm’s collection policy is its procedures for collecting a firm’s accounts receivable when they are due.  The effectiveness of this policy can be partly evaluated by evaluating at the level of bad expenses.  As seen in the previous examples, this level depends not only on collection policy but also on the firm’s credit policy.