2. WORKING CAPITAL MANAGEMENT
Gross and Net working capital
CR
QR
CASH BUDGET
WC POLICY
WCM

3. WORKING CAPITAL MANAGEMENT
OBJECTIVES OF WORKING CAPITAL
MANAGEMENT :
Optimising the investment in current assets
and liabilities
Ensuring that the company should always be in
a position to meet its current obligations,
supported by current assets available with the
firm.
The firm should manage its current assets in
such a way that the marginal return on
investment in these assets is not less than the
cost of capital employed to finance the current
assets.

4. 2 Approaches
► Balance Sheet approach
► Process approach

5. WORKING CAPITAL MANAGEMENT
Cash and Bank balances
Receivables
Inventory
Raw material, stores and
spares
Work - in - progress
Finished goods.
Prepaid expenses
Short-term advances
Temporary investments

6. WORKING CAPITAL MANAGEMENT
Current Liabilities include:
Creditors for goods purchased
Outstanding expenses i.e., expenses due but
not paid
Short-term borrowings
Advances received against sales
Taxes and dividends payable
Other liabilities maturing within a year.

7. WORKING CAPITAL MANAGEMENT
► More WC – reduces liquidity risk, effect on
the revenues and future growth, -ve effect
on CF, need for external funding
► Less WC – more CF, late payment to
suppliers, lost sales due to inventory
shortage and tight credit policy
► Dependent on the operations of the firm and
make up of working capital

8. WORKING CAPITAL MANAGEMENT
► Factors of WC changes on liquidity risk
 Access to financing
 State of the economy
 Uncertainty on future CFs
► WC should be large for firms
 Having more volatile revenues and CFs
 Smaller and have less access to external
financing

9. WORKING CAPITAL MANAGEMENT
Factors determining working capital
requirement :
Nature of business
Production policy
Market conditions
Seasonal variations
Supply conditions of materials

10. WORKING CAPITAL MANAGEMENT
Factors determining working capital
requirement :
Credit policy
Accessibility to credit
Growth and diversification of business

11. The Size of the Firm’s Investment in Current
Assets
► The size of the firm’s investment in
current assets is determined by its
short-term financial policies.
► Flexible policy actions include:
 Keeping large cash and securities balances
 Keeping large amounts of inventory
 Granting liberal credit terms
► Restrictive policy actions include:
 Keeping low cash and securities balances
 Keeping small amounts of inventory
 Allowing few or no credit sales

12. Carrying Costs and Shortage Costs
Short-term financial policy: the optimal investment in current assets.
Dollar
s
Total cost of
holding current
Minimum point assets
Carrying costs increase with the
level of investment in CA.
Shortage costs decrease with the
level of investment in CA.
Amount of
CA* current assets
(CA)
The optimal amount of current assets.
This point minimizes total costs.

13. A. Flexible policy- is most appropriate when carrying costs are low relative to
shortage costs.
Dollar
s
Minimum point
Total cost
Carrying costs
Shortage costs
Amount of
CA* current assets
(CA)

14. B. Restrictive policy- is most appropriate when carrying costs are high relative to
shortage costs.
Dollar
s
Minimum point
Total cost
Carrying costs
Shortage costs
Amount of
CA* current assets
(CA)

15. Financing Policy for an “Ideal” Economy
Dollars
Current assets =
Short-term debt
Long-term debt
plus common stock
Fixed assets
Time
0 1 2 3 4
In an ideal world, net working capital is always zero because
short-term assets are financed by short-term debt.

16. Alternative Asset Financing Policies
Policy F
Dollars Total asset
requirement
Marketable
securities
Long-term
financing
Fixed assets
Time
Policy F always implies a short-term cash
surplus and a large investment in cash and
marketable securities.

17. Policy R
Dollars Total asset
requirement
Short-term
financing
Long-term
financing
Time
Policy R uses long-term financing for
permanent asset requirements only and
short-term borrowing for seasonal
variations.

18. Dollars
Short-term
financing Flexible policy (F)
Total seasonal
variation Compromise policy (C)
Restrictive policy (R)
Marketable
General Matching
growth in fixed
securities assets and Principle
permanent
current assets
Time
With a compromise policy , the firm keeps a
reserve of liquidity which it uses to initially
finance seasonal variations in current asset
needs. Short-term borrowing is used when the
reserve is exhausted.

19. • The most common way to finance a
temporary cash deficit to arrange a short-term
loan.
• Accruals
• Trade credit
• Banks and FIs
• Public deposits
• ICDs
• CPs
• Factoring/ forfaiting
• RE/ SC/ Debentures/ TL – Long-term

20. Operating and Cash Cycles
►Operating Cycle - the time period
from inventory purchase until the
receipt of cash.
►Cash Cycle - the time period from
when cash is paid out, to when cash is
received.

21. OPERATING CYCLE
cash
cash
Collection of Purchase of
receivables raw materials
Accounts Raw material
Receivable inventory
Issue of materials to
sales production and
incurring expenses
Finished Work-in-process
goods
Collection of receivables

22. Raw material
Cash
purchased Finished goods sold
received
Order Stock
Placed Arrives
Inventory period Accounts receivable period
Time
Accounts payable period
Firm receives invoice Cash paid for materials
Operating cycle
Cash cycle

23. Operating Cycle
►The operating cycle-time to acquire
and sell inventory.
a) Finding the inventory period
Inventory turnover = COGS/ Avg inventory
Inventory period =365/ Inventory turnover

24. b) Finding the accounts receivable period-
time to collect on sale.
Receivables turnover = Credit sales / Avg
receivables
Receivables period =365/ Receivables turnover
Operating cycle = Inventory period +
Receivables period

25. Cash Cycle
►The cash cycle= Operating cycle - Accounts
payable period.
 Payable period = the time between receipt of
inventory and payment for it.
a) Finding the payables turnover
Payables turnover = COGS/ Avg payables
Payables period = 365/ Payables turnover
Cash cycle = Operating cycle - Payables
period

26. WORKING CAPITAL MANAGEMENT
Reasons for prolonged operating
cycle:
Purchase of materials in excess / short of
requirements
Buying inferior, defective materials
Failure to get trade discount, cash discount
Inability to purchase during seasons
Defective inventory policy
Lack of production planning, coordination and
control

27. WORKING CAPITAL MANAGEMENT
Reasons for prolonged operating
cycle:
Poor maintenance and upkeep of plant,
equipment and infrastructural facilities
Defective credit policy and slack collection
policy
Inability to get credit from suppliers,
employees
Lack of proper monitoring of external
environment etc.,
Use of outdated machinery, technology

28. WORKING CAPITAL MANAGEMENT
How to reduce operating cycle ?
 Purchase Management
 Production Management
 Marketing Management
 Sound Credit and Collection Policies
 Proper monitoring of External Environment

29. Process Approach
► All processes surrounding accounts payable,
accounts receivable and inventory
► Strategic drivers for action on working capital
 Unlocking internal cash is the cheapest way to fund
strategic projects
 Improving key ratios make the equity analyst to better
value the company
 Help secure access to capital market and bolster credit
rating

31. Customer to Cash
► Consistent policy throughout the firm –
cooperation within
► Ongoing vigilance over the people-process-
technology in the customer-cash cycle
► Spotting inefficiencies – reactive collection process
– pricing errors – ambiguous terms – product
issues
► When planning strategy – 2 principles –
concentrate resources on the clients that matters –
build responsibility in policies and procedures

32. Customer – cash cycle
► Customer negotiations
► Billing delays
► Collections – establish a system of
prioritized, proactive, event-driven collection
procedure

33. Purchase to Pay
► Structural problems
 Fragmentation
 Lack of focus
 Control and discipline
► Payment problems
 Early payment – input errors
 Default terms - automated
► Solution – approved channels
► E-procurement

34. Forecast to fulfilment
► What inventory do you have
► Where is inventory located
► How do you maintain its value
► Why do you have these quantities
► Service level to customers
► Understanding of the staff of their actions on
inventory and service
► Capabilities and requirements your suppliers and
customers have or deemand