Working Capital

Management Part 2
DYAN NICOLE M. FRANCISCO, CPA, MBA
 Summary of Last Meeting Discussion
Aggressive
Approach
Temporary CA
How will this Moderate
Current Assets be financed? Approach

Permanent CA Conservative
Approach
The working capital is managed by
considering the following:
▪Cost of short-term financing or bank loans
▪Cash and marketable securities management
▪Accounts receivable management
▪Inventory management
▪Accounts payable management
CASH AND MARKETABLE
SECURITIES
MANAGEMENT
 Money or other highly liquid assets that can be quickly
converted to cash.

CASH AND MARKETABLE

SECURITIES
MANAGEMENT
refers to the process of collecting, managing, investing,
and disbursing cash in a way that maximizes liquidity while
minimizing the risk of insolvency
Objectives:
▪ Cash Conversion Cycle
▪ Optimal Cash Balance
▪Collection and Disbursement Float
▪Cash management System
Cash Conversion Cycle
The length of time funds are tied up in working capital, or the length
of time between paying for working capital and collecting cash from
the sale of the working capital.

Inventory
Purchases in Accounts
Sales Payable

Accounts
Cash Payment of other current
Receivables
liabilities
 Inventory Conversion
Average time required to convert
raw materials to finished goods
PURCHASE and sell them.
DAY SALES IN INVENTORY

PAYMENT SALE

COLLECTION
Inventory Turnover
COGS
Inty Turnover =
Average Inventory

It measures the number of times that the inventory is replaced during the period.

Days Sales in 365

=
Inventory Inty Turnover

It indicates the average number of days during which the company must wait before the
inventories are sold.
 Inventory Conversion
Average time required to convert
raw materials to finished goods
PURCHASE and sell them.
DAY SALES IN INVENTORY

PAYMENT SALE

Average Collection
COLLECTION Average length of time required to
convert the firm’s receivable into
cash.
DAY SALES IN ACCOUNTS
RECEIVABLES
Receivable Turnover & Average
Collection Period
Credit Sales
AR Turnover =
Average Gross AR

It measures the number of times receivables are recorded and collected during the period.

Days Sales in 365

=
AR AR Turnover

It indicates the average number of days during which the company must wait before
receivables are collected.
 Operating Cycle
Operating Cycle = Days Sales in Inventory + Days Sales in AR

Inventory

Sales

Accounts
Cash
Receivables
 Inventory Conversion
Average time required to convert
raw materials to finished goods
PURCHASE and sell them.
DAY SALES IN INVENTORY

PAYMENT SALE

Payment Deferral Average Collection

Average length of time between
the purchase of materials and COLLECTION Average length of time required to
convert the firm’s receivable into
labor and the payment of cash to cash.
them.
DAY SALES IN ACCOUNTS
DAY SALES IN TRADE RECEIVABLES
PAYABLES
Accounts Payable Turnover
Net Credit Purchases
AP Turnover =
Average Accounts Payable

It measures the number of times payables are recorded and paid during the period.

Days Purchases 365

=
in AP AP Turnover

It indicates the length of time during which payables remain unpaid.

Cash Conversion Cycle
Cash Conversion Cycle = Operating Cycle – Days Purchases in AP

Average Age of Inventories + Average Age of Receivables

Average Age of Trade Payables CASH CONVERSION CYCLE

The length of time between company makes payment
to creditors and when company received payment to
customer.
Generally, The shorter CCC is, the better.
 FLOAT DELAY

It is the time delay between when a payment is

made by a payer and when the recipient actually
receives the funds.
 FLOAT
COLLECTION FLOAT DISBURSEMENT FLOAT
The delay when entity is notified of a time between when the entity initiates a
payment and when the funds are credited to payment and when the funds are debited
their account. from the entity’s account
During this period, the entity is aware of During this period, the entity's bank balance
the payment but has not yet gained access still reflects the funds, even though they have
to the funds been earmarked for payment.
Sources of Float
1.Mail Float
2.Processing Float
3.Clearing Float
1.Mail Float
The time it takes for a mailed payment (such as a check) to
reach its destination.
2. Processing Float
Delayed caused by the company’s internal control.
 DAYS

Mailing Float

Processing
Float COLLECTION/DISBURSEMENT
TIME

Clearing Float
Sources of Float
1.Mail Float
2.Processing Float COLLECTION FLOAT
The payee is aware that a payment has
3.Clearing Float been initiated, but they do not have
access to the funds until the payment is
fully processed and credited to their
account. This delay can impact the
payee's ability to use the funds for
operational needs or investments.
Sources of Float
1.Mail Float
2.Processing Float DISBURSEMENT FLOAT
Payment float can be
3.Clearing Float advantageous for the
payer as it allows them to
retain the use of their
funds for a little longer.
 NET FLOAT
NET FLOAT = DISBURSEMENT FLOAT COLLECTION FLOAT

Maybe stated in days or peso

Disbursement Float > Collection Float = Positive Net Float

Disbursement Float < Collection Float = Negative Net Float
How can we speed up collection?
1. Offer Incentives for Early Payments
2. Use Electronic Invoicing and Payments
3. Implement a Late Fee Policy
4. Utilize Online Payment Portals/Online Banking
5. Pre-authorized Checks or PDCs
6. Lockbox System
LOCKBOX SYSTEM
It is a banking service that would intercept payments and speed up collection because it reduces
the mail and processing float. In this system, the client will not mail their remittance checks to
the firm but to the numbered post office (P.O.) box instead, hence, reducing mail float. Then the
bank, with authorized agent, will collect the mail from the box and deposit them directly to the
bank account of the company on the same day, thereby reducing processing float.

In a lockbox system, the evaluation process involves the relationship that:

Incremental cost = Incremental benefit

This is to determine whether the system will be beneficial to the firm in terms of
reduction of float by installing additional lockbox. Now, we have this formula:

P = (D) x (S) x (i)

Where:
P – Incremental Profit
D – Days saved or reduced due to lockbox system
S – Average size of payment
I - Daily Interest Rate
OPTIMAL CASH BALANCE
TOO MUCH Results to idle unprofitable funds

ensures that a company can meet its regular financial

OPTIMAL CASH LEVEL obligations without disruption.

TOO LITTLE Results to liquidity problems.

Ways for determining the optimum
cash balance:
1. Minimizing Cost Models – EOQ
2. Calculation of Optimum Cash Balance - ECQ
3. Preparation of Cash Budget
 Economic Order Quantity (EOQ)
It is designed to help businesses determine the optimal order quantity that minimizes the total
inventory costs, balancing the costs of holding inventory and the costs of ordering or
replenishing it.

KEY COMPONENTS OF EOQ

H olding cost (H) The cost of holding or carrying one unit of inventory for a specified period. It includes
costs like storage, insurance, and opportunity cost of tied-up capital.

O rdering cost (S) The cost incurred each time an order is placed. It includes costs such as administrative
costs, shipping, and handling.

O rder quantity (Q) This represents the number of units a business should order each time to
minimize total inventory costs.

D emand (D) The annual demand for the product, expressed in units.
H olding cost (H)

O rdering cost (S) 2𝐷𝑆

O rder quantity (Q)
Q=
𝐻
D emand (D)

ASSUMPTIONS:
Demand
Price per unit
CONSTANT Holding cost
Ordering cost

Independent Orders
Instant delivery
 ECQ (Transaction Demand for Cash)
2 𝑥 𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝐶𝑜𝑠𝑡 𝑥 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 𝑓𝑜𝑟 𝐶𝑎𝑠ℎ
ECQ=
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 %

Optimal Cash balance is the point where total cost is

the minimum.
 CASH BUDGET PREPARATION
Cash, Beginning Balance Cash, Beginning Balance

Plus: Cash Inflows +/- Net Cash Flow from Operating Activity

Less: Cash Outflows +/- Net Cash Flow from Investing Activity

Cash, Ending Balance +/- Net Cash Flow from Financing Activity

Vs. Target Cash Balance Cash, Ending Balance

Cash Surplus/Deficit Vs. Target Cash Balance

Cash Surplus/Deficit
Marketable Securities Management
Marketable Securities are short term interest earning, money market instruments that can easily
be converted into cash.

TOO MUCH Results to idle unprofitable funds

INVEST IN MARKETABLE SECURITIES

OPTIMAL CASH LEVEL

TOO LITTLE Results to liquidity problems.

CONVERT BACK MS TO CASH
 Criteria for Investment
Return Safe to MaMa
The return of Ability of the security to MARKETABILITY MATURITY
investment or maintain its value for a The salability of the Period of time the
profitability of the given period of time. security when need security will be settled.
security. arises
 Maturity Safety Marketability

S-T Treasury 3-6 mos Excellent Excellent

L-T Treasury 1 – 10 yrs Excellent Excellent

Non-Gov’t Securities
Certificate of Deposit Good
3 Months Good
Commercial Papers Fair
Banker’s Acceptance Good
Money Market Funds Good
Open None
Repurchase Agreements Excellent
ACCOUNTS RECEIVABLE
MANAGEMENT
 Sales

Accounts
Cash
Receivables

Effective Receivable Management:

1. Prevention of late or non-payment
2. Effective credit management
Receivable Turnover & Average
Collection Period
Credit Sales
AR Turnover =
Average Gross AR

It measures the number of times receivables are recorded and collected during the period.

Days Sales in 365

=
AR AR Turnover

It indicates the average number of days during which the company must wait before
receivables are collected.
 CREDIT POLICY
1. Credit period – Length of time customers have
CREDIT to pay
TERMS
2. Discount – Price reduction for early/prompt
payment
3. Credit standards – Financial strength of
customer must exhibit to qualify for credit.
4. Collection policy - Degree of toughness in
enforcing the credit terms
e.g.2/10, net 30 days
Annualized Opportunity Cost

The result will give you an annualized percentage

that represents the cost of not taking advantage
of the early payment discount.
Your company has been offered credit terms of 4/30, net 90 days. What will be
the nominal annual percentage cost of its non-free trade credit if it pays 120
days after the purchase?
16.90%
WHY DO WE IMPLEMENT CREDIT
POLICY?
1.It has a major effect in sales
2.Influences the amount of funds tied
up in receivables
3.Affect bad debt losses
Consequences of Relaxing Credit Terms
Credit Sales
Accounts Receivables
Bad Debts
Collection Cost
Opportunity cost on incremental
investments in receivables
Sales Discount
 Credit Period

CREDIT TERMS Discount Period

Discount rate
 EFFECT OF CHANGING CREDIT TERMS
Increase in Credit Period
Variable Direction of Change Effect to Profit
Sales Volume Increase Increase

Accounts Receivables Increase Decrease

Bad Debts Expense Increase Decrease

 EFFECT OF CHANGING CREDIT TERMS
Increase in Discount Period and Discount Rate
Variable Direction of Change Effect to Profit
Sales Volume Increase Increase

Accounts Receivables
Non-discount takers Decrease Increase
Discount takers – paying late Increase Decrease
Bad Debts Expense Decrease Increase