WORKING CAPITAL AND

CASH MANAGEMENT
F I N A N C I A L M A N A G E M E N T P A R T 1
WORKING CAPITAL
• Working Capital = Current Asset - Current Liabilities
• Current Assets comprises cash, A/R , marketable securities,
inventory and prepaid assets.
• Current Liabilities are short-term obligations that are expected to
mature within one year such as A/P, Interest Payable, Android
Salaries Payable.
• It is used as a measure to check the liquidity of the firm.
• If Current assets > Current liabilities, then it is capable of paying
its current liabilities
• If Current assets < Current liabilities, then the firm cannot pay
its current obligations and has to resort to borrowings .
Illustration:
BB Co.
Balance Sheet
December 31, 20x4

Assets Liabilities and Stockholders' Equity

Current Assets Current Liabilities

Cash $ 20,000 Accounts Payable $
24,000
Accounts Receivable 60,000 Interest Payable
6,000
Inventory 84,000 $ 164, 000 Salaries Payable. 10,
000 $ 40,000
Non-Current Assets Long-term Liabilities
Equipment $ 180,000 Mortgage Payable
100,000
Investment in Bonds 72,000 252,000
Working Capital is Stockholders' Equity
276,000
computed as: Current liabilities:
Current assets:
Total Assets $ 416, 000 Total Liabilities and Stockholders' Equity
Cash $$20,000
416,000 A/P $ Working Capital= $164,000 - $
24,000 40,000
A/R 60,000 Notes Payable- short term = $ 124,000
6,000
WORKING CAPITAL MANAGEMENT

• It is concerned with the effecient and effective utilization of

working capital to attain the predetermined objectives of the
company relative to profitability of operation, liquidity of
financial resources, and minimization of risks and company
costs.
• It requires decisions on how the current asset will be financed
and utilized. Whereas, managing current liabilities implies
maximizing the company's holding period before the firm finally
pays off its obligations.
WORKING CAPITAL MANAGEMENT

• The goal of management is to maintain a cash level at a

minimum without putting the company at risk, thus maintaining
a level of cash that is enough to support the firm's operations.
However maintaining a cash is also hazardous to the company.
 Working Capital
Policies
01 02 03

Matching Policy Aggressive Conservative policy

Under this policy, all Policy
This type of policy has a high risk
The policy that has lower risk
and,often high return to the and lower return. The
the fixed assets plus company and the purpose of company matches portion of
the permanent current adapting this policy is to take the temporary current assets,
assets are financed by opportunity of having lower interest and the entire permanent
charge for short-term liabilities current assets and fixed
long-term liabilities or instead of long-term debt.
assets with long-term
equity. liabilities or equity
 Matching policy
This policy provides
WORKING
moderate risk and
CAPITAL moderate return to the
POLICIES company.
AGGRESSIVE POLICY

This policy puts the

company at risk for
financing a portion of the
permanent of permanent
current assets.
Conservative
Policy
Among the three
working capital policies,
the conservative Policy
has lowest risk, lowest
return.
 HOW IS WORKING
CAPITAL
MANAGED?

01 02
Looking at the Putting up proper
financial internal control
ratios
 HOW IS WORKING
CAPITAL
MANAGED?

03 04
Changing Preparing the
company budget
policies
CASH
MANAGEMENT
• Cash is a current asset used to purchase raw materials, pay for
labor , buy capital assets, and pay for dividends, taxes, and
obligations.
• The objective of cash management is to minimize the use of cash
and maintain optimum cash at the right time.
• Cash management is also concerned with the acceleration of cash
receipts and suspension of cash disbursements.
 Why maintain
Cash?
01 02 03

Transaction Speculative Precautionary Motive

Motive Motive
 Transaction Motive

This refers to the intention to

meet the minimum business
operations requirement.

WHY MAINTAIN
CASH?
 Speculative Motive

The use of cash balance to take

advantage of bargain purchases
on materials or unusual cash
discounts.

WHY MAINTAIN
CASH?
 Precautionary
Motive
This results in holding cash for
WHY unseen fluctuations in cash
MAINTAIN inflow and outflow.

CASH?
CASH EQUIVALENTS

• These are short-term, highly liquid investments that are readily

convertible to cash.

Examples:
• 90-day Treasury bill
• A 180-day Treasury bill purchased within 90 days before it's
maturity
• 90-day time deposit
• Long-term commercial paper purchased within 90 days before
it's maturity
Arowwai Industries

ADVANTAGES OF HOLDING
CASH & CASH EQUIVALENTS

Taking advantage Maintenance of Favorable Meeting

of the trade good credit rating business emergencies and
Capacity to compete
discounts opportunities
 FACTORS AFFECTING CASH
REQUIREMENTS

Firm's Policy on Cash Management Forcasted Cash inflow and

- refers to the amount of cash a outflow
Forecasting cash movements
firm needs to cover for a certain helps the firm ascertain the
number of days of the business proper timing of financing and
operations . debt repayment.
Availability of loans Unpredictable events
- A firm with good credit standing Estimating unpredictable events may
may hold a cash balance at low save a lot of time and money for the
levels without putting the firm at firm.
risk.
 Possible placement for
excess Cash
01 02 03

Savings and/or Time deposits Stocks

current
accounts
Treasury Commercial
bills paper
0 05
 CONTROLLING CASH FLOWS

• Controlling the cash flow is the main objective of cash

management.
The following tools maye be used for controlling cash flows:

1.Synchronizing cash flow

2.Cash floats on
a. payments
b. collections
3. Extending cash payments
4. Availing of cash discounts
5. Optimum transaction size
1. SYNCHRONIZING CASH FLOWS

- A process in which the cash inflows coincide with the cash outflows.

-It is highly dependent on an accurate forecast of inflows and

outflows.

-Accurate forecast helps the firm minimize its cash balance.

- As a result, there will be less borrowings, lower interest expense, and

maximized profit.
2. FLOATS ON DISBURSEMENTS
These are the differences between the company's book balance and
bank account balance in any period of time.
✓ A float can be classified into three categories:

a. Mail float- from the time the check is issued up to the time the
check is received by the payee.

b. Processing float- from the time the check is received by the

payee until the time it is deposited in the payee's bank account.

c. Clearing float- from the date the check is deposited up to the date
the check is cleared and made available for use.
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Collecting center or agent

-collection center can be a firm providing a collection service, or bank
where payments are made directly to the firm's account. Having a
collecting center near the customer may even lead to a zero float, making
the check collection as good as cash.
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Collecting center or agent

Example : Ariana Grabe Corporation has an agreement with RCBC to
collect $ 3M a day in exchange for compensating balance of $1M. The
firm, with a significant increase in it's customer in the area, is thinking of
cancelling the agreement and dividing the service provided by RCBC with
Doggie Bank. With this plan, RCBC will handle the collection of $2M with a
compensating balance of $800k. On the other hand, Doggie Banks will
handle the other $1M collection in exchange for compensating balance of
$700k. With the planned arrangements with the two banks to perform the
collection, the firm is expecting to reduce the collection period by one day.
The firm's rate of return is 9%. Should Ariana Grabe Corporation pursue
the division of service between RCBC and Doggie Bank?
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Collecting center or agent

Analysis:

Amount of cash collection per day $ 3,000,000

No. of days freed on the collection x 1
Amount of cash freed $ 3,000,000
Less: Increase in compensating balance 500,000
increase in cash flow $ 2,500,00
Rate of return x 0.09
Incremental Income $ 225,000
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Lockbox System
- it is a system where the company has a "P.O" box number" address.
This P.O box is rented in a postal office where all collection made by the
customer will be directed to. Lockboxes are normally managed by banks.
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Lockbox System
Example : Forda Go Corporation has average cash receipts of $ 150,000
per day. Normally, it takes 7days from the time the check is received for it
to be made available as cash. How much is tied up?

Computation:

Average cash receipts per day $ 150,000

No. of days tied up x 7
Amount of cash tied up $ 1,050,000
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Concentration banking

-Another way of accelerating the collection of funds .

-It has many forms such as direct sends where checks are sent
directly to the drawee bank; direct deposit to the company's
bank account, provided that the bank is already on-line; and an
auto-debit arrangement wherein the payee's account is credited
that of the payor is debited.
 ACCELARATING OF FUNDS BY REDUCING COLLECTION FLOAT

• Concentration Banking
Example: A firm's monthly average cash balances are computed as
follows:

Monthly Average Cash Balance

1 $ 25,000
2 30,000
3 40,000
4 60,000
Total $ 155,000

Monthly Average cash balance = $155,000 ÷ 4

= $ 38,750
3. EXTENDING CASH
DISBURSEMENTS

• Ways to conduct Cash disbursements:

1.Playing th float
2.Payment by draft
3.Auto-debit transfer
4.Debit transfer
5.Stretching of payables
6.Centralization of disbursements
7.Use of statistics to predict the amount of checks issued
AVAILING OF CASH DISCOUNTS

• Cash discount is categorized under short-term financing.

• Cash discount is offered by suppliers of goods to the purchasers to
encourage them to make an early payment.
• The credit term is a payment term where credit is granted to the
customer.
 FORMULA OF CASH DISCOUNT

Cost of discount = Discount % x 360

100% - Discount % Final due date-

Discount period
✓ Before availing cash discount, the firm should conduct a
cost- benefit analysis first.
✓ Borrowing rate > cost of discount - better not to avail cash
discount
✓ Borrowing rate < cost of discount - better to avail cash discount
DETERMINATION OF OPTIMAL TRANSACTION
SIZE
• Cash Management model recognizes two types of costs relative to
the level of working cash balances. These are transaction costs
and opportunity costs.
• Transaction costs - fixed costs in buying or selling the securities
• Opportunity costs - refers to the interest income if marketable
securities are obtained.
 RELEVANT COST

Relevant Cost = Transaction costs + Opportunity costs

= FC x CR + I x MS
MS 2
Where:
MS - amount of marketable securities sold each time the cash balance
is
replenished.
FC - the fixed cost associated with the transaction
CR - the total cash required for the given period of time
I - the rate of return on the marketable securities
RECEIVABLE MANAGEMENT

F I N A N C I A L M A N A G E M E N T P A R T 1
 RECEIVABLES
- represents the amount of money to be collected from individuals
or firms.

- frequently arises from the sale of merchandise or the performance

of services, and granting of loans to officers, employees, and
stockholders.

- it includes items such as claims from the advances to officers,

employees, affiliates, and other outside parties.
GENERAL CLASSES
OF RECEIVABLES

01 02
Trade Non-trade
Recievables Receivables
FACTORS THAT AFFECT THE SIZE OF RECEIVABLES

1.Term Credits
2.Paying practices of the customers
3.Collection Policies
4.Volume of Credit Sales
 ACCOUNT RECEIVABLE MANAGEMENT

-- account receivable must be properly handled like any

composition of assets to efficiently achieve the firm's goal of
maximizing it's stockholder's wealth.

- it is the process of determining, handling, and administering

account receivable related to sales and credit policies.
 • Trade Credit
✓ Firm's grant credits in order to increase the sales volume. Nevertheless,
it also means investing or increasing the company's account receivables.

Example:
Jetjet Corporation sells on term of net/30. On the average, its accounts
are 30 days past due. Annual credit sales are $ 150,000. What is the
average accounts receivable?

Computation:
60/ 360 x $ 150,000 = $25,000

✓ The $25,000 represents the average accounts receivable itself not the
investment.
 • Trade Credit
Firms invest in accounts receivable through trade credits for the following
purposes:

a. To increase the current sales volume

b. To retain the current sales
 COSTS TO BE EXPECTED
BY THE COMPANY

Bad debt Expense Cost of Capital

Variable and fixed

Cash discounts
cost
CREDIT POLICY
- the firm's credit policy influences its sales, cost of sales, and
profits.

Components of Credit Policy :

1. Term Credit

2. Credit Standards

3. Collection policy
 TERM CREDIT
- this establishes a firm's proposal on how the goods and services
are to be sold.

- this includes the credit period and cash discount.

✓ Credit Period - lenght of time in which credit sales are allowed.

It varies from one industry to another.
✓ Cash discounts - given to customer to entice prompt payment.
 RELAXING TERM CREDIT

✓ Relaxing the term credit means that from the existing practice of
the company, a more lenient term is implemented.

✓ For instance, from a current practice of n/30 days, the firm may
decide to change it to n/45 or more days.

Minimum required rate of return = Incremental Income

Incremental working
 CREDIT STANDARDS
- are guidelines followed by the company in giving credit sales to
customers.

- it also refers to the financial strength and credit worthiness a

customer must exhibit in order to qualify for credit.
 The five C's of credit

01 02 03

Character Capacity Capital

Conditio Collater
ns al
0 05
Arowwai Industries

SOURCES OF CREDIT
INFORMATION

Financial Credit-rating Commercial banks Trade checking

Statements agencies
 COLLECTION POLICY
- it refers to the guidelines on handling receivables in terms of
monitoring and collection.

- a well established collection policy has a crystal clear procedure

as to the sequence of collecting the account receivables.

- the process usually starts by sending a billing statement when the

due date is near. When payment is not received on the due date,
another letter is sent to inform the devtir that its account is not yet
paid.
 FACTORS IN EVALUATING
RECIEVABLE MANAGEMENT
1. Ratio of A/R to Net credit sales 3. Average collection period
- used as determinant to see if the
company is too lenient or too strict in - refers to the number of days of
implementing it's credit and collection sales in accounts receivable.
policy

2. Receivable Turnover 4. Aging of Accounts

- how fast accounts receivable are Receivable
- way of identifying clients who are
converted into cash. paying their obligation within the
prescribed credit term.
 DESIRED LEVEL OF RECEIVABLES

Receivables = Net Credit Sales x Required collection

period
360
Example: Gwapa Co. would like to maintain a balance of $150,000 in
its accounts receivable account. If the company has a credit sale of
$3,500,000 a year, what should be the required collection period of
Gwapa Co. be?
 DESIRED LEVEL OF RECEIVABLES

Answer:

Receivables = Net Credit Sales x Required collection

period
360
$ 150,000 = $ 3,500,000 x Required collection period
360
Required collection period = $ 150,000
$ 3,500,000
. 360
= 15. 43 days
Arowwai Industries

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