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1 
CChhaapptteerr 88 
OOvveerrvviieeww ooff 
WWoorrkkiinngg CCaappiittaall 
MMaannaaggeemmeenntt
2 
OOvveerrvviieeww ooff WWoorrkkiinngg 
CCaappiittaall MMaannaaggeemmeenntt 
 Working Capital Concepts 
 Working Capital Issues 
 Financing Current Assets: 
Short-Term and Long-Term Mix 
 Combining Liability Structure 
and Current Asset Decisions
3 
WWoorrkkiinngg CCaappiittaall CCoonncceeppttss 
NNeett WWoorrkkiinngg CCaappiittaall 
Current Assets - Current Liabilities. 
GGrroossss WWoorrkkiinngg CCaappiittaall 
The firm’s investment in current assets. 
WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt 
The administration of the firm’s current assets and 
the financing needed to support current assets.
4 
SSiiggnniiffiiccaannccee ooff WWoorrkkiinngg 
CCaappiittaall MMaannaaggeemmeenntt 
 In a typical manufacturing firm, current 
assets exceed one-half of total assets. 
 Excessive levels can result in a substandard 
Return on Investment (ROI). 
 Current liabilities are the principal source of 
external financing for small firms. 
 Requires continuous, day-to-day managerial 
supervision. 
 Working capital management affects the 
company’s risk, return, and share price.
5 
SSuummmmaarryy ooff tthhee OOppttiimmaall 
AAmmoouunntt ooff CCuurrrreenntt AAsssseettss 
SSUUMMMMAARRYY OOFF OOPPTTIIMMAALL CCUURRRREENNTT AASSSSEETT AANNAALLYYSSIISS 
PPoolliiccyy LLiiqquuiiddiittyy PPrrooffiittaabbiilliittyy RRiisskk 
AA HHiigghh LLooww LLooww 
BB AAvveerraaggee AAvveerraaggee AAvveerraaggee 
CC LLooww HHiigghh HHiigghh 
1. Profitability varies inversely with 
liquidity. 
2. Profitability moves together with risk. 
(risk and return go hand in hand!)
6 
CCllaassssiiffiiccaattiioonnss ooff 
WWoorrkkiinngg CCaappiittaall 
CCoommppoonneennttss 
Cash, marketable securities, 
receivables, and inventory 
TTiimmee 
Permanent 
Temporary
7 
PPeerrmmaanneenntt 
WWoorrkkiinngg CCaappiittaall 
TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss rreeqquuiirreedd ttoo 
mmeeeett aa ffiirrmm’’ss lloonngg--tteerrmm mmiinniimmuumm nneeeeddss.. 
PPeerrmmaanneenntt ccuurrrreenntt aasssseettss 
TIME 
DOLLAR AMOUNT
8 
TTeemmppoorraarryy 
WWoorrkkiinngg CCaappiittaall 
TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss tthhaatt vvaarriieess 
wwiitthh sseeaassoonnaall rreeqquuiirreemmeennttss.. 
PPeerrmmaanneenntt ccuurrrreenntt aasssseettss 
TIME 
DOLLAR AMOUNT 
TTeemmppoorraarryy ccuurrrreenntt aasssseettss
9 
FFiinnaanncciinngg CCuurrrreenntt AAsssseettss:: 
SShhoorrtt--TTeerrmm aanndd LLoonngg--TTeerrmm MMiixx 
SSppoonnttaanneeoouuss FFiinnaanncciinngg:: Trade credit, and 
other payables and accruals, that arise 
spontaneously in the firm’s day-to-day 
operations. 
Based on policies regarding payment for 
purchases, labor, taxes, and other expenses. 
We are concerned with managing non-spontaneous 
financing of assets.
10 
HHeeddggiinngg ((oorr MMaattuurriittyy 
MMaattcchhiinngg)) AApppprrooaacchh 
AA mmeetthhoodd ooff ffiinnaanncciinngg wwhheerree eeaacchh aasssseett wwoouulldd bbee ooffffsseett wwiitthh 
aa ffiinnaanncciinngg iinnssttrruummeenntt ooff tthhee ssaammee aapppprrooxxiimmaattee mmaattuurriittyy.. 
Short-term financing** 
TIME 
DOLLAR AMOUNT 
Long-term financing 
CCuurrrreenntt aasssseettss** 
FFiixxeedd aasssseettss
11 
HHeeddggiinngg ((oorr MMaattuurriittyy 
MMaattcchhiinngg)) AApppprrooaacchh 
** Less amount financed spontaneously by payables and accruals. 
**** In addition to spontaneous financing (payables and accruals). 
Short-term financing** 
TIME 
DOLLAR AMOUNT 
Long-term financing 
CCuurrrreenntt aasssseettss** 
FFiixxeedd aasssseettss
12 
FFiinnaanncciinngg NNeeeeddss aanndd 
tthhee HHeeddggiinngg AApppprrooaacchh 
Fixed assets and the non-seasonal portion 
of current assets are financed with long-term 
debt and equity (long-term profitability 
of assets to cover the long-term financing 
costs of the firm). 
Seasonal needs are financed with short-term 
loans (under normal operations 
sufficient cash flow is expected to cover the 
short-term financing cost).
13 
SSeellff--LLiiqquuiiddaattiinngg NNaattuurree 
ooff SShhoorrtt--TTeerrmm LLooaannss 
Seasonal orders require the purchase of 
inventory beyond current levels. 
Increased inventory is used to meet the 
increased demand for the final product. 
Sales become receivables. 
Receivables are collected and become cash. 
The resulting cash funds can be used to pay 
off the seasonal short-term loan and cover 
associated long-term financing costs.
14 
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff 
((CCoonnsseerrvvaattiivvee AApppprrooaacchh)) 
FFiirrmm ccaann rreedduuccee rriisskkss aassssoocciiaatteedd wwiitthh sshhoorrtt--tteerrmm bboorrrroowwiinngg 
bbyy uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff lloonngg--tteerrmm ffiinnaanncciinngg.. 
TIME 
DOLLAR AMOUNT 
Long-term financing 
CCuurrrreenntt aasssseettss 
FFiixxeedd aasssseettss 
SShhoorrtt--tteerrmm ffiinnaanncciinngg
15 
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff 
((CCoonnsseerrvvaattiivvee AApppprrooaacchh)) 
LLoonngg--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss 
Less worry in refinancing short-term obligations 
Less uncertainty regarding future interest costs 
LLoonngg--TTeerrmm FFiinnaanncciinngg RRiisskkss 
Borrowing more than what is necessary 
Borrowing at a higher overall cost (usually) 
RReessuulltt 
Manager accepts less expected profits in 
exchange for taking less risk.
16 
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff 
((AAggggrreessssiivvee AApppprrooaacchh)) 
Firm increases risks associated with short-tteerrmm bboorrrroowwiinngg bbyy 
uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff sshhoorrtt--tteerrmm ffiinnaanncciinngg.. 
Short-term financing 
TIME 
DOLLAR AMOUNT 
Long-term financing 
CCuurrrreenntt aasssseettss 
FFiixxeedd aasssseettss
17 
CCoommppaarriissoonn wwiitthh aann 
AAggggrreessssiivvee AApppprrooaacchh 
SShhoorrtt--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss 
 Financing long-term needs with a lower interest 
cost than short-term debt 
 Borrowing only what is necessary 
SShhoorrtt--TTeerrmm FFiinnaanncciinngg RRiisskkss 
 Refinancing short-term obligations in the future 
 Uncertain future interest costs 
RReessuulltt 
 Manager accepts greater expected profits in 
exchange for taking greater risk.
18 
SSuummmmaarryy ooff SShhoorrtt-- vvss.. 
LLoonngg--TTeerrmm FFiinnaanncciinngg 
Financing 
Maturity 
Asset 
Maturity 
SHORT-TERM LONG-TERM 
Low 
Risk-Profitability 
Moderate 
Risk-Profitability 
Moderate 
Risk-Profitability 
High 
Risk-Profitability 
SHORT-TERM 
(TTeemmppoorraarryy) 
LONG-TERM 
(PPeerrmmaanneenntt)
19 
CCoommbbiinniinngg LLiiaabbiilliittyy SSttrruuccttuurree 
aanndd CCuurrrreenntt AAsssseett DDeecciissiioonnss 
The lleevveell ooff ccuurrrreenntt aasssseettss and the 
mmeetthhoodd ooff ffiinnaanncciinngg tthhoossee aasssseettss are 
iinntteerrddeeppeennddeenntt. 
A ccoonnsseerrvvaattiivvee ppoolliiccyy of “high” levels of 
current assets allows a more aaggggrreessssiivvee 
method of financing current assets. 
A ccoonnsseerrvvaattiivvee method of financing 
(all-equity) allows an aaggggrreessssiivvee ppoolliiccyy 
of “low” levels of current assets.

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Overview of working capital management

  • 1. 1 CChhaapptteerr 88 OOvveerrvviieeww ooff WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt
  • 2. 2 OOvveerrvviieeww ooff WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt Working Capital Concepts Working Capital Issues Financing Current Assets: Short-Term and Long-Term Mix Combining Liability Structure and Current Asset Decisions
  • 3. 3 WWoorrkkiinngg CCaappiittaall CCoonncceeppttss NNeett WWoorrkkiinngg CCaappiittaall Current Assets - Current Liabilities. GGrroossss WWoorrkkiinngg CCaappiittaall The firm’s investment in current assets. WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt The administration of the firm’s current assets and the financing needed to support current assets.
  • 4. 4 SSiiggnniiffiiccaannccee ooff WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard Return on Investment (ROI). Current liabilities are the principal source of external financing for small firms. Requires continuous, day-to-day managerial supervision. Working capital management affects the company’s risk, return, and share price.
  • 5. 5 SSuummmmaarryy ooff tthhee OOppttiimmaall AAmmoouunntt ooff CCuurrrreenntt AAsssseettss SSUUMMMMAARRYY OOFF OOPPTTIIMMAALL CCUURRRREENNTT AASSSSEETT AANNAALLYYSSIISS PPoolliiccyy LLiiqquuiiddiittyy PPrrooffiittaabbiilliittyy RRiisskk AA HHiigghh LLooww LLooww BB AAvveerraaggee AAvveerraaggee AAvveerraaggee CC LLooww HHiigghh HHiigghh 1. Profitability varies inversely with liquidity. 2. Profitability moves together with risk. (risk and return go hand in hand!)
  • 6. 6 CCllaassssiiffiiccaattiioonnss ooff WWoorrkkiinngg CCaappiittaall CCoommppoonneennttss Cash, marketable securities, receivables, and inventory TTiimmee Permanent Temporary
  • 7. 7 PPeerrmmaanneenntt WWoorrkkiinngg CCaappiittaall TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss rreeqquuiirreedd ttoo mmeeeett aa ffiirrmm’’ss lloonngg--tteerrmm mmiinniimmuumm nneeeeddss.. PPeerrmmaanneenntt ccuurrrreenntt aasssseettss TIME DOLLAR AMOUNT
  • 8. 8 TTeemmppoorraarryy WWoorrkkiinngg CCaappiittaall TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss tthhaatt vvaarriieess wwiitthh sseeaassoonnaall rreeqquuiirreemmeennttss.. PPeerrmmaanneenntt ccuurrrreenntt aasssseettss TIME DOLLAR AMOUNT TTeemmppoorraarryy ccuurrrreenntt aasssseettss
  • 9. 9 FFiinnaanncciinngg CCuurrrreenntt AAsssseettss:: SShhoorrtt--TTeerrmm aanndd LLoonngg--TTeerrmm MMiixx SSppoonnttaanneeoouuss FFiinnaanncciinngg:: Trade credit, and other payables and accruals, that arise spontaneously in the firm’s day-to-day operations. Based on policies regarding payment for purchases, labor, taxes, and other expenses. We are concerned with managing non-spontaneous financing of assets.
  • 10. 10 HHeeddggiinngg ((oorr MMaattuurriittyy MMaattcchhiinngg)) AApppprrooaacchh AA mmeetthhoodd ooff ffiinnaanncciinngg wwhheerree eeaacchh aasssseett wwoouulldd bbee ooffffsseett wwiitthh aa ffiinnaanncciinngg iinnssttrruummeenntt ooff tthhee ssaammee aapppprrooxxiimmaattee mmaattuurriittyy.. Short-term financing** TIME DOLLAR AMOUNT Long-term financing CCuurrrreenntt aasssseettss** FFiixxeedd aasssseettss
  • 11. 11 HHeeddggiinngg ((oorr MMaattuurriittyy MMaattcchhiinngg)) AApppprrooaacchh ** Less amount financed spontaneously by payables and accruals. **** In addition to spontaneous financing (payables and accruals). Short-term financing** TIME DOLLAR AMOUNT Long-term financing CCuurrrreenntt aasssseettss** FFiixxeedd aasssseettss
  • 12. 12 FFiinnaanncciinngg NNeeeeddss aanndd tthhee HHeeddggiinngg AApppprrooaacchh Fixed assets and the non-seasonal portion of current assets are financed with long-term debt and equity (long-term profitability of assets to cover the long-term financing costs of the firm). Seasonal needs are financed with short-term loans (under normal operations sufficient cash flow is expected to cover the short-term financing cost).
  • 13. 13 SSeellff--LLiiqquuiiddaattiinngg NNaattuurree ooff SShhoorrtt--TTeerrmm LLooaannss Seasonal orders require the purchase of inventory beyond current levels. Increased inventory is used to meet the increased demand for the final product. Sales become receivables. Receivables are collected and become cash. The resulting cash funds can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.
  • 14. 14 RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff ((CCoonnsseerrvvaattiivvee AApppprrooaacchh)) FFiirrmm ccaann rreedduuccee rriisskkss aassssoocciiaatteedd wwiitthh sshhoorrtt--tteerrmm bboorrrroowwiinngg bbyy uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff lloonngg--tteerrmm ffiinnaanncciinngg.. TIME DOLLAR AMOUNT Long-term financing CCuurrrreenntt aasssseettss FFiixxeedd aasssseettss SShhoorrtt--tteerrmm ffiinnaanncciinngg
  • 15. 15 RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff ((CCoonnsseerrvvaattiivvee AApppprrooaacchh)) LLoonngg--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss Less worry in refinancing short-term obligations Less uncertainty regarding future interest costs LLoonngg--TTeerrmm FFiinnaanncciinngg RRiisskkss Borrowing more than what is necessary Borrowing at a higher overall cost (usually) RReessuulltt Manager accepts less expected profits in exchange for taking less risk.
  • 16. 16 RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff ((AAggggrreessssiivvee AApppprrooaacchh)) Firm increases risks associated with short-tteerrmm bboorrrroowwiinngg bbyy uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff sshhoorrtt--tteerrmm ffiinnaanncciinngg.. Short-term financing TIME DOLLAR AMOUNT Long-term financing CCuurrrreenntt aasssseettss FFiixxeedd aasssseettss
  • 17. 17 CCoommppaarriissoonn wwiitthh aann AAggggrreessssiivvee AApppprrooaacchh SShhoorrtt--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss Financing long-term needs with a lower interest cost than short-term debt Borrowing only what is necessary SShhoorrtt--TTeerrmm FFiinnaanncciinngg RRiisskkss Refinancing short-term obligations in the future Uncertain future interest costs RReessuulltt Manager accepts greater expected profits in exchange for taking greater risk.
  • 18. 18 SSuummmmaarryy ooff SShhoorrtt-- vvss.. LLoonngg--TTeerrmm FFiinnaanncciinngg Financing Maturity Asset Maturity SHORT-TERM LONG-TERM Low Risk-Profitability Moderate Risk-Profitability Moderate Risk-Profitability High Risk-Profitability SHORT-TERM (TTeemmppoorraarryy) LONG-TERM (PPeerrmmaanneenntt)
  • 19. 19 CCoommbbiinniinngg LLiiaabbiilliittyy SSttrruuccttuurree aanndd CCuurrrreenntt AAsssseett DDeecciissiioonnss The lleevveell ooff ccuurrrreenntt aasssseettss and the mmeetthhoodd ooff ffiinnaanncciinngg tthhoossee aasssseettss are iinntteerrddeeppeennddeenntt. A ccoonnsseerrvvaattiivvee ppoolliiccyy of “high” levels of current assets allows a more aaggggrreessssiivvee method of financing current assets. A ccoonnsseerrvvaattiivvee method of financing (all-equity) allows an aaggggrreessssiivvee ppoolliiccyy of “low” levels of current assets.