The Professional CPA Review School

Main: 3F C. Villaroman Bldg. 873 P. Campa St. cor Espana, Sampaloc, Manila
( (02) 8735 8901 / 0917-1332365
email add: crc_ace@yahoo.com/crcacemanila.onlineenrollment@gmail.com
Baguio Davao
DE GUZMAN Bldg. 18 Legarda Road, Baguio City 3/F GCAM Bldg. Monteverde St. Davao City
( 0921-7566143 ( 0917-1332365

MANAGEMENT ADVISORY SERVICES OCTOBER 2022 BATCH

WEEK 11

TOPIC 15 - WORKING CAPITAL MANAGEMENT (LECTURE NOTES)

Working Capital – are short-term assets that a company uses in its day-to-day operations and one of
the measures of a company’s short-term solvency, which is its ability to pay liabilities as they
become due.

Net Working Capital – is the difference between current assets and current liabilities.

Advantage of Adequate Working Capital Disadvantages of Inadequate Working Capital

1. Prompt settlement of debts 1. The risk of business failure increase
2. Increase in sales volume due to 2. Lack funds will result to non-pursuant of the
credit granting to customers team’s objective
3. Inventories can be readily Disadvantages of Excessive Working Capital
replenished 1. Inefficiency and complacent of management
4. Current operating expenses are 2. Temptation for too much speculation
paid on-time 3. Incurrence of unnecessary expenses
5. Profitable opportunities can be 4. Non-optimal employment of resources
taken advantage of

Types of Working Capital

1. Permanent working capital - is the minimum amount of working capital that is maintained at
all times
2. Temporary working capital – is the increases that occur from time to time.

Working Capital Strategy

Temporary Assets Permanent Assets
Temporary Financing Hedging Aggressive
Permanent Financing Conservative Hedging
Components of Working Capital
1. Cash and Cash Equivalents
2. Marketable Securities
3. Accounts Receivable.
4. Inventory

Inventory Management
Objectives of an Inventory Management System: Minimize total costs associated with managing
inventory.

Basic Costs Associated With Inventory

1. Carrying (Holding) Costs – storage, insurance, cost of capital for holding inventory too long,
property taxes, depreciation, and obsolescence.
2. Ordering Costs – placing orders, custom duties, shipping and handling costs.
3. Costs of Stock-Out – lost sales, reduced customer goodwill (effects on sales), and the
disruption of production schedules.

Tools in Managing the Inventory

1. Stock Management Models
a. Economic Order Quantity - How much stock should we order?
i. Carrying Costs = Ordering Costs
1. Total Carrying Costs:
2. Total Ordering Costs:
ii. Methods:
1. Tabular Method
 Page 2

2. Formula Method

Whereas: D = Annual Demands; O = Cost per Order; C = Carrying Cost per Unit
b. Re-Order Point – When to order?
i. Lead Time
ii. Daily Usage (Annual Demands ÷ Operating or Working days)
iii. Safety Stock (Maximum Daily Usage – Normal Daily Usage) * Lead Time in
Days
iv. Control Procedures: Red-line method & Two-Bin Method
c. Materials Resource Planning System
d. Just-In Time System
e. Outsourcing

Receivable Management
Objectives: Efficient credit and collection policies and procedures will improve firm’s profitability
(increase in sales) and liquidity (efficient flow of cash).

Factors that affect the Receivable Balances:

1. The level of credit sales (versus Cash Sales) as a percentage of sales. This percentage will
vary with the type of business.
2. The level of sales. Higher the sales, greater the accounts receivable.
3. The credit and collection policy.

Major Decisions to be made:

1. Credit Standards (will they pay as per agreement?) – Credit Scoring, Credit Reports, Past
Experience, and Financial Analysis (Debt Ratios, Liquidity Ratios, & Profit Ratios) Note:
Tighter standards tend to reduce sales, but reduce bad debt expense. Fewer bad debts
reduce Days Sales Outstanding.
2. Credit Terms
a. Credit Period – How long to pay? Shorter period reduces DSO and average A/R, but it
may discourage sales.
b. Cash Discounts – Lowers price but attracts new customers and reduces Days Sales
Outstanding.
3. Collection Policy (How tough?)
a. Standard Operating Procedures
b. Be professional, firm, and do not bluff.
c. Vary procedures with slow payers.
Note: Tougher policy will reduce Days Sales Outstanding (release of investment in
receivables) but may damage customer relationships.
4. Reducing the Risk of Non-Collection
a. Advance payments
b. Offset of amounts owed against amounts due
c. Requiring a third-party guarantee
d. Legal title of the goods is not passed to the customer until they are paid for
e. Insurance to cover the costs of any legal expenses incurred in recovering debt
f. Insurance against the risk of non-payment

Evaluating Receivable Management Techniques:

1. Average Collection Period
2. Bad Debt to Sales Ratio
3. Aging Accounts Receivable
4. Receivables to Assets Ratio
5. Credit Sales to Receivables Ratio.

Cash Management
Basic Objectives: Maintaining cash balances (through efficient cash inflow and outflow cycle) that will
meet operating requirements and will permit optimization of idle funds through investments (either
long or short term)
Reasons for Holding Cash
1. Transactions or Operations requirements
2. Precautionary (for contingencies and unexpected losses)
3. Speculative (investment purposes)
4. Contractual (as required by a contract, example is compensating or maintaining balances in
bank accounts)
 Page 3

Tools for Managing Cash

1. Prompt Billings and follow-ups (Relationship with customer)
2. Offering discounts (Cost of Discount = %)
3. Availability and accessibility of Collection system
4. Legal actions (for delinquent accounts)
5. Lockbox plan
a. Traditional
i. Concept: A post office box maintained by a firm’s bank that is used as a
receiving point for customer remittances.
ii. Process:
1. Customers are instructed to mail their remittances to the lockbox
location.
2. Bank picks up remittances several times daily from the lockbox.
3. Bank deposits remittances in the customer’s account and provides a
deposit slip with a list of payments.
4. Company receives the list and any additional mailed items.
b. Electronic - A collection service provided by a firm’s bank that receives electronic
payments and accompanying remittance data and communicates this information to
the company in a specified format.
6. Concentration Banking – the movement of cash from lockbox or field banks into the firm’s
central cash pool residing in a concentration bank.
a. Compensating Balance – Demand deposits maintained by a firm to compensate a bank
for services provided, credit lines, or loans.
b. Advantages
i. Improves control over inflows and outflows of corporate cash.
ii. Reduces idle cash balances to a minimum.
iii. Allows for more effective investments by pooling excess cash balances.
c. Types of Transfers
i. Depository Transfer Check (DTC) - A non-negotiable check payable to a single
company account at a concentration bank. (The funds are not immediately
available for use)
ii. Automated Clearinghouse (ACH) Electronic Transfer - An electronic version of
the depository transfer check (DTC)
iii. Wire Transfer - A generic term for electronic funds transfer using a two-way
communications system. Funds are available upon receipt of the wire transfer
but much more expensive.
7. Pre-authorized debits (Auto-debits in bank accounts) – the transfer of funds from a payor’s
bank account on a specified date to the payee’s bank account; the transfer is initiated by the
payee with the payor’s advance authorization.
8. Delaying payments (see financing working capital)
9. Managing floats
10. Zero Balance Bank Accounts
11. Lines of Credit (see financing working capital)

Evaluating Cash Management System

1. Optimal Cash Balance Computation (the cash balance level that permits the firm to meet
currently maturing obligations but not to large so that the firm avoids the incurrence of
opportunity cost on holding excess cash)
2. Formula:

Where:
F = Fixed costs of a transaction (Cost of withdrawing and/or investing in
marketable securities)
T = Total cash required for the specified time period
I = Interest rate on marketable securities in relation to the specified time
period
3. Float Period (the time it takes for both checks issued and collected to be cleared by the bank)
a. Disbursement Floats – pertains to checks issued by the firm
b. Collection Floats – pertains to checks collected by the firm
i. Mail Float – the time it takes for the check issued by the customer to reach the
firm.
ii. Processing Float – the time it takes for the firm to deposit the check
iii. Clearing or Availability Float – the time it takes for the bank to clear the check
4. Cash Conversion Cycle – the average period where in cash is invested in current assets.
a. Components:
i. Inventory Conversion Period (ICP) = Inventory ÷ Sales/Day
ii. Receivable Collection Period (RCP)= Receivable ÷ Sales/day
 Page 4

iii. Payable Deferral Period (PDP) = Payables ÷ Cost of Sale/Day or Purchases/Day

b. Formula:

Managing Marketable Securities

Objective: To maintain a level of short-term very liquid investments that will ensure quick
replenishment of cash balances due to possible shortages and obtaining a higher returns than is
possible maintaining cash.
Types of Investment in Marketable Securities
1. Ready Cash Segment - Optimal balance of marketable securities held to take care of probable
deficiencies in the firm’s cash account.
2. Controllable Cash Segment - Marketable securities held for meeting controllable
(determinable) future outflows, such as interest and dividends.
3. Free Cash Segment - “Free” marketable securities (that is, available for as yet unassigned
purposes).
Characteristics of a good investment in marketable securities
1. Safety – Refers to the likelihood of getting back the same number of pesos you originally
invested (principal)
2. High degree of Liquidity – meaning, it can be sold quickly but low cost of transaction and no
price pressure effect when buying and selling
3. Tax Benefits

Financing Working Capital

Objective: Establishing the lowest possible cost of short-term financing.
Sources of Short-Term Financing
1. Accrual of Expenses
2. Trade Payables
a. Cost of Foregoing the Cash Discount
b. Free Trade Credit – credit received during the discount period.
c. Costly Trade Credit – credit received beyond the discount period.
3. Short –Term Bank Loans
a. Cost of Bank loans (Effective versus Nominal)
i. Simple Interest
ii. Discounted Interest
iii. Compensating Balance and Interest income
4. Commercial Paper (Short-term Promissory Note)
5. Receivable Financing
a. Factoring – outright sale of accounts receivable
b. Assignment – receivables are used as collateral and collection from these receivables
are used as remittance for payment.
c. Pledging – receivable are used as collateral and will be forfeited in favor of the creditor
in the event of loan default.
d. Haircut – an amount deducted from the face value of the receivable as insurance
against risks or default or non-payment.
6. Inventory Financing
a. Blanket Inventory Lien
b. Trust Receipt/Chattel Mortgage Agreement
c. Warehousing
 Page 5

WORKING CAPITAL MANAGEMENT (PRACTICE PROBLEMS)

General Concept
Problem 1: Shaw Corporation is considering a plant expansion that will increase its sales and net
income. The following data represent management's estimate of the impact the proposal will have:
Before After
Cash P 100,000 P 120,000
Accounts payable 350,000 430,000
Accounts receivable 400,000 500,000
Inventory 380,000 460,000
Marketable securities 200,000 200,000
Mortgage payable (current) 175,000 225,000
Fixed assets 2,500,000 3,500,000
Required: Determine the effect of the plant expansion on Shaw's net working capital.

Inventory Management
Problem 2: A television manufacturer buys wooden cabinet from outside suppliers at P 400 per set.
Total annual needs are 5,000 units at a rate of 20 sets per working day. The following cost data are
available:
Desired annual returns on inventory investment (10% @ P400) P 40
Rent, Insurance, and Taxes per unit P 10
Annual Carrying Costs per unit P 50
Cost of Ordering P 50/order
Required:
1. Using the tabular method and the following order sizes, compute the EOQ of the raw
materials: (20, 40, 50, 100, 200, 300)
2. Using the formula method, compute for the EOQ
3. Using the computed EOQ, compute the Annual ordering costs and annual carrying costs.

Problem 3: Manila uses EOQ logic to determine the order quantity for the nylon fabric its uses in
the manufacturing of its flags. Forecasted monthly demand for nylon fabric is for 100,000 yards. The
setup costs associated with placing and receiving each nylon fabric order is P50.00. It is estimated
that the cost to carry a yard of nylon fabric in inventory for a year is P10.00.
Required:
1. Calculate the nylon fabric EOQ for Manila.
2. Compute for the annual carrying cost of Manila using its EOQ.
3. How much is the annual ordering cost of Manila using its EOQ?

Problem 4: The following information is available for Panay Corporation:

Annual demand (in units) 100,000
Working days per year 250 days
Normal Lead Time in Working days 3 days
Required:
1. Compute Panay’s Re-order Point.
2. Compute Panay’s safety stock level and re-order point if based on experience its maximum
lead time is 7 working days.

Problem 5: The current inventory level of a particular raw material is 4,000 units. It was determine
that the company 25 days left before it needs to re-order. The annual demand of the raw material is
36,000 and there is 360 production days in a year.
Required:
1. What is the re-order point?
2. If the normal lead time is 10 days, how many was in the safety stock?
3. What was the maximum lead time used in determining the level of safety stock?

Problem 6: Boston Corporation uses 30,000 units. Each order placed is for 1,500 units. The stock-
out units is 300. Management is willing to accept a stock-out probability of 40 percent. The stock-out
cost per unit is P3.20.
Required: What is the total stock-out cost?
 Page 6

Problem 7: Each stock-out of Applesider sold by Apple Company costs P87,500 per occurrence.
The carrying cost per unit of inventory is P250 per year and the company orders 1,500 units of
product 24 times a year at a cost of P5,000 per order. The probability of stock-out at various
possible levels of safety stock is:
Units of Safety Stock Probability of Stock-Out
0 .50
100 .30
200 .14
300 .05
400 .01

Required: Determine the optimal safety stock level for Apple Company.

Receivable Management
Problem 8: Albay Company’s credit sales are P 300,000, and the collection period is 90 days.
Cost is 70 percent of selling price. Albay’s cost of capital is at 10%.
Required:
1. Determine Albay’s average investment in accounts receivable.
2. A proposal to relax the company’s credit term will result to a 20% increase in sales and the
collection period will increase to 120 days. What is Albay’s new average investment in
accounts receivable?
3. What is the net benefit of the proposed policy?

Problem 9: Jolo Corporation, which has idle capacity, provides the following data:
Selling price per unit P80
Variable cost per unit P50
Fixed cost per unit P10
Annual credit sales 300,000 units
Collection period 2 months
Rate of return 16%
The corporation is considering a change in policy that will relax its credit standards. The following
information applies to the proposal:
• Sales will increase by 20 percent.
• Collection period will go to 3 months.
• Bad debt losses are expected to be 3 percent of the increased sales.
• Collection costs are expected to increase by P20,000.
Required: What is the net benefit (cost) if Jolo will relax its credit standards?

Problem 10: Central Producers is contemplating relaxing its credit terms. The company currently
sells its product for P50. Last year, the firm sold 75,000 units. It is estimated that 80% of sales are
on credit. The variable cost per unit is P30. The relaxation of credit terms is expected to result in the
following:
• A 15% increase in unit sales
• An increase in the average collection period from 36 days to 45 days, and
• An increase in bad debt expenses from 1.5% of credit sales to 2% of credit sales.
• An increase in collection cost from P 60,000 to P 90,000.
The company's cost of capital if 14%.
Required: What is the net benefit (cost) if Central will relax its credit standards?

Problem 11: Lakeside Corporation provides the following data:

Current annual credit sales P 12,000,000
Collection Period 2 months
Credit Terms Net /30
Rate of Return 15%
Lakeside proposes to offer a 3/10, net/30 discount. The corporation anticipates 25 percent of its
customers will take advantage of the discount. As a result of the discount policy, the collection
period will be reduced to 1 ½ months.

Required: Determine if Lakeside should offer the new terms?

 Page 7

Problem 12: Dagupan Corporation has annual credit sales of P5 million and debtors pay within 60
days. The company proposes to offer a 2 percent discount for payment within 30 days and expects
60 percent of customers to use the discount. Remaining customers will continue to take 60 days and
the level of sales will remain unchanged. Administration costs would fall by P 50,000.

Required: If the company's cost of short-term finance is 12 percent, calculate the expected benefit
of the proposed policy (to the nearest P500).

4.0 Cash Management

Problem 13: On a typical day, Abra Company writes checks totaling P 3,000. These
checks clear in 7 days. Simultaneously, the company receives P1,700. The cash is available in 2 days
on average.

Required: Calculate the disbursement, the collection, and the net floats

Problem 14: Batangas Corporation has daily cash receipts of P 65,000. A recent analysis of its
collections indicated that customer’s payments were in the mail an average of 2.5 days. Once
received, the payments are processed in 1.5 days. After payments are deposited, it takes an
average of 3 days for these receipts to clear the banking system.

Required:
1. How much collection float (in days) does the firm currently have?
2. If the firm’s opportunity cost is 11 percent, would it be economically advisable for the firm to
pay an annual fee of P 16,500 in order to reduce collection float by 3 days?

Problem 15: It currently takes 6 days to receive and deposit payments from customers. A lockbox
will cut this time down to 4 days. Average daily collections are estimated at P 150,000. Idle funds
earn 5% and the total annual costs for a lockbox will be P 30,000.
Required:
1. Should the company adopt a lockbox plan?
2. What is the minimum number of days that should be cut for the plan to be advantageous to
the company?

Problem 16: A firm has daily cash receipts of P300,000 and is interested in acquiring a lockbox
service in order to reduce collection time. The proposals are summarized below:
Reduction in
Bank Cost (Monthly)
Collection Time
Allied Bank P 4,800 3 days
Banco de Oro P 5,000 4 days
Bank of the Philippine Islands P 2,000 1 day
Security Bank P 1,000 2 days
Required: If money market rates are expected to average 6% during the year, and the firm
wishes to maximize income, which bank should the firm choose?

Problem 17: Travis Company has an agreement with Charter Bank in which the bank handles P3
million in collections a day and requires a P 700,000 compensating balance. Travis is thinking of
canceling the agreement and dividing its western region so that two other banks will handle its
business instead. Bank A will handle P1 million a day of collections, requiring a compensating
balance of P 300,000, and bank B will handle the other P2 million a day, asking for a compensating
balance of P 500,000. Travis’s financial manager anticipates that collections will be accelerated ¼
day if the western region is divided. The company’s rate of return is 14 percent.
Required: Determine whether the company should implement the new arrangement or not.

Problem 18: Green Corporation anticipates a cash requirement of P1,000 over a 1-month period. It
is expected that cash will be paid uniformly. The annual interest rate is 24 percent. The transaction
cost of each borrowing or withdrawal is P30.

Required:
1. What is the optimal transaction size?
2. What is the average cash balance?
 Page 8

Problem 19: You estimate a cash need for P4 million over a one month period where the cash
account is expected to be disbursed at a constant rate. The opportunity interest rate is 6 percent per
annum. The transaction cost each time you borrow or withdraw is P100.

Required: Compute for the optimal transaction size and the average cash balance.

5.0 Marketable Securities

Problem 20: Mandaluyong Corporation has P2 million in excess cash that is might invest in
marketable securities. In order to buy and sell the securities, the firm must pay a transaction fee of
P 45,000.

Required:
1. Would you recommend purchasing the securities if they yield 12 percent annually and are
held for (a) One month, (b) Two months, (c) Three months, (d) Six months, and (e) One
year?
2. What is the minimum required yield would the securities have to return for the firm to hold
them for three months?

6.0 Financing Current Assets

Problem 21: Compute the cost of foregoing the discount when the term are
1. 3/15, n/60
2. 2/10, net 30
3. 4/10, net 40

Problem 22: Tagaytay Corporation needs P 2,000,000 to finance its operation. The following are
the different options that the company has in order to raise such funds:

Required: Compute the cost of financing under each of the following independent cases:
1. Loan with interest at maturity of 21%
2. Loan with interest, taken in advance, at the rate of 18%
3. Loan, with interest of 17% at maturity, and a required compensating balance of 20%
4. Loan, with interest of 16% discounted, and a compensating balance of 15%
5. Loan, with interest of 18% at maturity, and a 15% compensating balance that earns 4%.
6. Loan, with interest of 15% discounted, and a 30% compensating balance that earns 5%.
7. Commercial paper that pays interest of 20% and issue cost amounting to P 50,000.

Problem 23: Tres Bigotilyos Inc. needs to pay a supplier’s invoice of P60,000 and wants to take a
cash discount of 2/10 net 40. The firm can borrow the money for 30 days at 11% per annum with a
9% compensating balance. Assume 360-day year.
Required:
1. What is the amount Tres Bigotilyos must borrow to pay the supplier within the discount
period and cover the compensating balance?
2. Assuming Tres Bigotilyo borrows the money on the last day of the discount period and repays
it 30 days later, what is the effective interest rate on the loan?
3. If Tres Bigotilyo fails to take the discount and pays on the 40th day, what is cost for not
taking the discount?

Problem 24: (Cost of Factoring): A factor will purchase Ryan Corporation’s P 120,000 per month
accounts receivable. The factor will advance up to 80 percent of the receivables for an annual charge
of 14 percent, and a 1.5 percent fee on receivables purchased.

Required: Determine the cost of this factoring arrangement.

/mbg