- Working capital management focuses on a company's current assets and current liabilities. It aims to optimize the amount of funds tied up in short-term assets to balance liquidity needs with reducing opportunity costs. - Key components of working capital include cash, inventory, accounts receivable, and accounts payable. Companies must determine the optimal level of each based on their sales levels and growth strategies. - There are three main approaches to working capital management: relaxed, moderate, and restricted. The cash conversion cycle model also examines how long it takes for a company to convert cash outflows on inventory into cash inflows from sales.

1. WORKING CAPITAL
MANAGEMENT
By: Noor ul hadi Lecturer GCMS Peshawar

2. Working Capital Management
• Working Capital Management is another
important area of financial management.
• – Working Capital Management is
component of financial management that
focuses on Current Assets & Liabilities of
Balance Sheet in day-to-day operation.

3. Working Capital Terminology:
• Working capital is also called gross working capital,
simply refers to current assets used in operations.
• Working Capital (Gross) = Current Assets
• – Current Assets = Inventory + Accounts Receivables +
Cash + Marketable Securities +
• …(The mentioned items are four major items)
• – Working Capital is different from “Capital” (as used
in Capital Budgeting) which refers
• to Capital Expenditure in Fixed Assets
• – Also it is different from “Capital” (as used in Capital
Structure) which refers to
• Financing in the form of Debt or Equity (Loans or share
capital)

4. Working Capital Terminology:
• Net Working Capital = Current Assets – Current Liabilities
• Net working capital is slightly different from gross working capital.
• – working capital is different from Net Worth
• = Assets – Liabilities = Equity
• = Stock + Retained Earnings
• – Current Liabilities
• = Accounts Payables + Accruals + Short Term Loans + (as well as
other minor items)
• • Important Measure of the Short-term Liquidity of a Firm
• – Working capital is a measure of how easy it is for a firm to
convert short-term assets
• into “Liquid” Cash in order to meet the Current Obligations by selling
assets

5. Terminology
• – Some ratios to measure liquidity of firm are:
• Current Ratio = Current Assets / Current Liabilities
• Acid Test or Quick Ratio = Quick Assets / Current
Liabilities
• • Quick Assets = Current Assets – Inventory
• • Fundamental Tradeoff in Working Capital (or Current
Assets)
• Decision in working capital management is how much
working capital should be maintained by a firm. It
requires how much money needs to be invested in
Inventory, Accounts Receivables, Marketable Securities
and how much cash should be maintained.

6. Current Assets
• Advantages of Large Current Assets:
• less risk of shortages & interruptions and less loss
• of sales due to availability of funds for lo an payments and purchases and
inventory.
• High Liquidity so better CREDIT Rating.
• Advantages of Small Current Assets:
• Less investment in current assets means less amount of money tied to the
assets which are generating no return. So lower Opportunity Cost of Capital.
• – Find the Optimum Current Assets (working capital) At Any Given Time
and for a
• Given Level of Sales & Growth:
• • For this Alternative Investment Policies have been proposed and a good
• business judgment is required

7. Working Capital Policies:
• • What is the Optimum Working Capital
(or Current Assets) for a Firm at any given
time given in level of Sales and Growth
Strategy? This requirement fluctuates with
time depending on sales and seasons.

8. Type of policy in Working Capital
Practically the following policies are used by
the mangers to decide what is the best
amount of current assets or mix of
assets to be kept for the firm:
1. Relaxed Policy
2. Moderate Policy
3. Restricted Policy

9. 1. “Fat Cat” or Relaxed Policy
– It requires Large Amount of Current Assets not
to loose any sales i. e. when a customer
• places order for a large amount, there is no
shortage of inventory
– Occurs when High sales driven by lot of credit
facility to buyers
– Good Credit Rating because High Liquidity and
good Current Ratio
– Case: Wall Mart retail chain during New Year
and Christmas

10. 2.“Lean & Mean” or Restricted Policy
– Small Amount of Current Assets
– It increases turnover and therefore Profits
• Current Asset Turnover = Sales / Current Assets. Higher than 20.
• Lowers Carrying Costs of Inventory
– Frees up cash and speeds up production (operational efficiency)
– Small Current Assets means Lower Opportunity Cost of Capital. Firms have
raised
Capital from Investors (Debt Holders and Shareholders) which comes at a Cost
(the WACC includes Interest paid to Debt Holders and Dividends paid to
Shareholders).
Firms must mobilize the capital in high-return investments in order to repay
their investors.
– “Zero Working Capital Policy” (Extreme form of Lean & Mean Policy)
It can not be 0 in reality but its objective is to minimize.
• Japanese Just in Time (JIT) i.e. Toyota Motor Co. It means the spare parts
reach
just a few hours ago from the assembly time.

11. 3.Moderate Policy
– In between the Fat Cat and Lean & Mean
Policies
Impact of working capital on Firm Value:
There is a link between working capital
policy and our basic objective of financial
management of maximizing shareholder’s
wealth.

12. MANAGING THE COMPONENT
OF WORKING CAPITAL
• WORKING CAPITAL CONSIST FOUR MAIN
COMPONENT
– CASH
– MARKETABLE
– INVENTORIES
– ACCOUNT RECIEVABLE
For each type of assets, fundamental trade off: that current assets
are necessary to conduct business, and the greater the holding
of current assets, the smaller the danger of running business,
holding current asset is costly if inventories are too large, then
the firm will have asset with zero or negative return.

13. Cash Management
• The cash conversion cycle:
Conversion cycle include purchase of inventory, sell goods
on credit, and the collect account receivable. The cycle is
referred to as the cash conversion cycle, sound working
capital is designed to minimizes the time between cash
expenditures on material and the collection of cash on
sale.
The cash conversion cylce model focused on the length of
time between when the company makes payment and
when it receives cash inflow, the following term are used
in the model.

14. 1. Inventory conversion period.
It is the average time required to convert material
into finashied goods and thet o sell those good.
It is calculated as follow:
Inventory conversion period=
inventory /sale per day
For example average inventory is 2,000,000 and
sale are 10000000 then conversion period
=2000000/(10000000)360 =72 days

15. 2. Receivable collection period
RCP is the average length of time required
to convert the firm’s receivable into cash, it
is also called days sale outstanding.
RCP or DSO= Receivable / (sale/360)
If average receivable are 666,667 and sale
is 10 million.
DSO=666667 / (10000000/360) =24 days

16. 3. Payable deferral period.
• PDP is averagge length of time between
purchase of materials and labor and
payment of cash for them.
• PDP= payable / avg purchases per day
• = payables / cost of goods sold/360
If cost of goods sold is 8million and account payable
average is 666,667;
PDP = 666667/ (8000000/360)
PDP = 30 days.

17. Cash conversion Cycle
It is nets out the three periods
(ICP,RCP,PDP)