FM 101

WORKING
CAPITAL
MANAGEMENT
Ms. VENUS CHARISSE L. MABILING
Lecturer- FM 101
INTENDED LEARNING OUTCOMES
1. Understand the factors determining a firm's working
capital needs.

2. Learn how to manage cash and debt efficiently.

3. Solve problems relating to the time value of money.

4. Discuss the basics of financial markets and the stock

exchange
WHAT IS WORKING CAPITAL?
It represents operating liquidity available to a
business, organization, or other entity, including
governmental entity.

It involves in managing inventory, accounts

receivable and payable and cash.
WORKING CAPITAL MANAGEMENT
It involves decisions relating to working capital and
short term financing.
The goal of working capital management is to
ensure that the firm is able to continue its
operations and that it has sufficient cash flow to
satisfy both maturing short term debt and
upcoming operational expenses.
 APPROACHES TO FINANCE
CURRENT ASSETS
1. Matching Approach
The firm adopts a financial plan involves the
matching of the expected life of assets with the
expected life of the sources of funds raised to finance
assets.
The firm uses long term funds to finance permanent
assets and short term funds to finance temporary
assets.
 APPROACHES TO FINANCE
CURRENT ASSETS
2. Conservative Approach

Low return-low risk approach

The firm that follows this type of approach means it
depends more on long term funds for financing needs.
The firm finance its permanent and temporary assets
with long term funds which are more expensive than
short term funds.
 APPROACHES TO FINANCE
CURRENT ASSETS
3. Aggressive Approach

High-risk approach
Under this approach, the firm decides to finance
permanent and temporary assets by short term
sources.
It is a high return approach because it relies more on
short term funds that are costly but riskier.
 DETERMINANTS OF
WORKING CAPITAL NEEDS
1. Nature and size of the business
2. The firm’s manufacturing cycle
3. Business fluctuations
4. Production policy
5. Firm’s credit policy
6. Availability of credit
7. Growth and expansion activities
 FACTORS DETERMINE WORKING
CAPITAL NEEDS OF A FIRM
1. AVAILABILITY OF CREDIT
Amount of credit that a firm can obtain, as also the
length of the credit period significantly affects the
working capital requirement.
 FACTORS DETERMINE WORKING
CAPITAL NEEDS OF A FIRM
2. GROWTH AND EXPANSION
The working capital requirements increase with growth
and expansion of business. The implementation of the
production plan that aims at the growth or expansion of
the unit necessitates more of fixed capital and working
capital both.
 FACTORS DETERMINE WORKING
CAPITAL NEEDS OF A FIRM
3. PROFIT AND DISTRIBUTION
The net profit of a firm is a good index of the resources
available to it and meet its capital requirements.
The larger the amount of cash profit, the greater will be
the possibility of acquiring working capital.
 FACTORS DETERMINE WORKING
CAPITAL NEEDS OF A FIRM
4. PRICE LEVEL FLUCTUATIONS
When prices rise, a firm will require more funds to
purchase its current assets.
If possible to pass on the burden of high prices of raw
materials to the customers by raising the prices of final
product, then also there will be no increase in working
capital requirements.
 FACTORS DETERMINE WORKING
CAPITAL NEEDS OF A FIRM
5. OPERATING EFFICIENCY
If a firm is efficient, it can use its resources economically,
and thereby it can reduce cost and earn more profit.
Thus, the working capital requirement can be reduced by
more efficient use of the current assets.
IMPORTANCE OF WORKING CAPITAL
MANAGEMENT
1. Time devoted to working capital
management
2. Investment in current assets
3. Importance to small firms
4. Relationship between sales and current
assets
WHAT IS CASH MANAGEMENT?
It helps to identify the cash balance which allows
for the business to meet the day to day expenses,
but reducing cash holding costs.
CASH CYCLE refers to the amount of time that
elapses from the point when the firm makes a cash
outlay to purchase raw materials to the point when
cash is collected from the sale of finished goods
produced using those raw materials.
CASH TURNOVER refers to the frequency of a firm’s
cash cycle during a year.
 APPLICATION- CASH MANAGEMENT
XYZ Ltd. currently purchases all its raw materials on
credit and sells merchandise on credit. The credit
terms extended to the firm currently require its
customers to pay within 60 days of a sale.
However, the firm on average takes 35 days to pay
its accounts payable and the average collection
period is 70 days. On average, 85 days’ elapse
between the point a raw material is purchased and
the point the finished goods are sold. Determine
cash cycle and turnover.
APPLICATION- CASH MANAGEMENT
CCC= INVENTORY CONVERSION PERIOD
+ PAYABLE COLLECTION PERIOD
- PAYABLE DEFERRAL PERIOD

CCC= 85 DAYS - 35 DAYS + 70 DAYS

= 120 DAYS

CASH TURNOVER = 365

CCC

CASH TURNOVER= 365

120 3.04 TIMES
 APPLICATION- CASH MANAGEMENT
A manufacturing company, VCM Corporation takes
40 days to collect the customer payments and 60
days to convert its finished products into sales.
Meanwhile, Crediti Inc. and VCM Corporation
created an agreement that every 28 days, VCM
Corporation shall pay its obligations at Php
10,598.00. Determine the cash conversion cycle
and the cash turnover of the company.
SETTING THE OPTIMAL CASH BALANCE

A. CASH BUDGET

It shows the firm’s projected cash inflows and

outflows over some specified period.
It is a statement in which estimated future cash
receipts and payments are tabulated in such way to
show the forecast cash balance of a business at
defined intervals.
CASH BUDGET SECTIONS

1. Beginning Cash Balance

2. Cash Collections
3. Cash disbursements
4. Cash excess or
deficiency
5. Financing
6. Ending Cash Balance
 REASONS FOR KEEPING CASH
Cash is usually referred to as the “king” in finance, as
it is the most liquid asset.
The transaction motive refers to the money kept
available to pay expenses.
The precautionary motive refers to the money kept
aside for unforeseen expenses.
The speculative motive refers to the money kept
aside to take advantage of suddenly araising
opportunities.
ADVANTAGES OF SUFFICIENT CASH
Current liabilities may be catered for meeting the
current obligations of the company
Cash discounts are given for cash payments
Production is kept moving
Surplus cash may be invested on a short-term basis
The business is able to pay its accounts in a timely
manner, allowing for easily obtained credit.
Liquidity
Quick upfront pay
SETTING THE OPTIMAL CASH BALANCE

B. BAUMOL’S MODEL (William J. Baumol)

An application of the EOQ (Economic Order Quantity)

inventory model to cash management. Its
assumptions are:
1. The firm uses cash at a steady predictable rate
2. The cash outflows from operations also occurs at a
steady rate
3. The cash net outflows also occur at a steady rate.
 SETTING THE OPTIMAL CASH BALANCE

C. MILLER-ORR MODEL (Merton Miller & Daniel Orr)

It is a stochastic (probabilistic) model which makes the

more realistic assumption of uncertainty in cash flows.

Assumed that the distribution of daily net cash flows is

approximately normal.
 SETTING THE OPTIMAL CASH BALANCE
D. CASH MANAGEMENT TECHNIQUES

To pay accounts payable as late as possible without

damaging the firm’s credit rating.

Turnover inventory as quickly as possible, but avoid

stockouts.

Collect accounts receivable as quickly as possible.

 CASH MANAGEMENT TECHNIQUES
1. CONCENTRATION BANKING

Firms with regional sales outlets can designate certain of

these as regional collection center.

It reduces the amount of time that elapses between the

customers’ mailing of a payment and the firm’s receipt of
such payment.
 CASH MANAGEMENT TECHNIQUES
2. Lock-box System

The customer sends the payments to a post office box. The

post office box is emptied by the firm’s bank at least once
or twice each business day. The bank opens the payment
envelope, deposits the checks in the firm’s account and
sends a deposit slip indicating the payment received to the
firm.
 SETTING THE OPTIMAL CASH BALANCE
E. INVENTORY MANAGEMENT
It helps to identify the level of inventory which allows for
uninterrupted production but reduces the investment in
raw materials and minimizes reordering costs-and hence
increases cash flow.
TYPES OF INVENTORY: Raw Materials, Work-in progress and
Finished goods inventory
The firm must determine the optimal level of inventory to be
held so as to minimize the inventory relevant cost.
 DEBTORS’ MANAGEMENT
It helps to identify the appropriate credit policy, i.e.
credit terms that will attract customers, such that any
impact on cash flows and the cash conversion cycle
will be offset by increased revenue and return on
capital.

In order to keep current customers and attract new

ones, most firms find it necessary to offer credit.
 ACCOUNTS RECEIVABLE
ACCOUNTS RECEIVABLE = CREDIT SALES PER DAY
X LENGTH OF COLLECTION PERIOD

The average collection period depends on:

Credit standards
Credit period
Discount given for early payments
The firm’s collection policy
AVERAGE COLLECTION PERIOD DEPENDS ON...
CREDIT STANDARDS
Follows a lenient credit policy and tends to sell credit to
customers on very liberal terms and credit is granted for a
longer period.

SELLS CREDIT ON A
INCREASED IN
SELECTIVE BASIS TO
SALES AND CUSTOMERS WHO
CONTRIBUTION HAVE PROVEN
MARGIN CREDITWORTHINESS
 LENIENT CREDIT POLICY
Increase bad debt losses
Opportunity cost of tied-up capital in
receivables
Increased cost of carrying out credit
analysis
Increased collection cost
Increased discount costs to encourage early
payments.
AVERAGE COLLECTION PERIOD DEPENDS ON...
CREDIT TERMS
It involves both the length of the credit period and the
discount given.
In considering the credit terms to offer the firm should
look at the profitability caused by longer credit and
discount period or a higher rate of discount against
increased cost.
AVERAGE COLLECTION PERIOD DEPENDS ON...
DISCOUNTS
It involves an attempt to speed up the payment of
receivables. It can result in reduced bad debt losses.

COLLECTION POLICY
The higher the cost of collecting accounts receivables
the lower the bad debt losses.
The firm must therefore consider whether the
reduction in bad debt is more than the increase in
collection costs.
EVALUATION OF THE CREDIT APPLICANT
1. The applicant’s financial statement
2. Credit ratings and reports from experts
3. Banks
4. Other firms
5. The company’s own experience
DISCRIMINATIVE ANALYSIS
A statistical model that can be used to accept or
reject a prospective credit customer.
T
I O
M F
E
M
V O
A N
L E
U Y
E
 TIME VALUE OF MONEY
It is an important explanation for the worth of money
relative to the passage of time. It helps a finance
manager evaluate different investments to give
qualified advice to the business owner or the corporate
executives.
A PESO TODAY IS WORTH MORE THAN A DOLLAR
TOMORROW.
A PESO RECEIVED TOMORROW IS WORTH LESS THAN A
DOLLAR RECEIVED TODAY.
 TIME VALUE OF MONEY
PRESENT VALUE (PV)
pesos INVESTED yesterday
pesos INVESTED today

FUTURE VALUE (FV)

pesos RECEIVED in the future
pesos WITHDRAWN today

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 TIME VALUE OF MONEY
APPLICATIONS- FUTURE VALUE OF SINGLE AMOUNT
1. Aiza invested Php 300,000.00 in a bank over a
period of 6 years earning an interest at 5% p.a.
Determine the future on this amount.
period amount at start interest amount at end
Year 1 Php 300,000 Php 15,000 Php 315,000
Year 2 ? ? ?
Year 3 ? ? ?
Year 4 ? ? ?
Year 5 ? ? ?
Year 6 ? ? ?
 TIME VALUE OF MONEY
n
FV= PV (1+r)

PV= FV n PV= FV (1+r) -n

(1+r)

PV= present value

FV= future value
r= annual rate of interest
n= number of effective interest rate periods (years)
 TIME VALUE OF MONEY
APPLICATIONS- PRESENT VALUE OF A SINGLE AMOUNT
2. Assume that Rizel will receive Php. 1,000,000 two years
from now in her investment security. If the interest of the
security is 3.5% per annum, determine the present value
of the amount she invested.
PV= FV n PV= FV (1+r) -n
(1+r)
period amount at start interest amount at end
Year 1 ? ? ?
Year 2 ? ? Php. 1,000,000
FINANCIAL MARKETS
FINANCIAL MARKET
A market for funds where
buyers and sellers bring
together to trade in a
commodity.

CATEGORIES n
-n

Capital & money markets

Primary and secondary markets
Organized and over the counter
markets
 CATEGORIES OF FINANCIAL MARKETS
PRIMARY MARKET SECONDARY MARKET
Transfer of new financial Trading of already issued
instruments (cash, shares, securities.
and debt capital) If the company is to make a
public issue of ordinary share
n capital, the-nissue will take place
in primary market. If initial
purchasers wish to dispose off
the shares, trading will take place
in the secondary market
 CATEGORIES OF FINANCIAL MARKETS
CAPITAL MARKET MONEY MARKET
A financial market for long A financial market for short
term securities. term securities.
Shares and bonds Promissory notes, commercial
paper, treasury bills and
-n
n certificate of deposits
It is regulated by central
banks
 -n
n
 ADVANTAGES TO S.E. QUOTATIONS
1. It is easy for quoted companies to obtain underwriters
when issuing shares.
2. Quotations attract investors to a share issue since they
can easily dispose of their shares.
3. It enhances public confidence.
4. A quoted company will be able to get access to relevant
information through the stock exchange and also be able
-n
n
to get comparative data reflecting the performance of
other quoted companies.
5. In an inefficient market, a quoted company will be able to
obtain up-to-date information or feedback regarding
share prices in stock exchanges.
WHAT IS PSE?
PRODUCTS & SERVICES
A stockbroker is compensated for
his services in executing orders
on the Exchange through
commission charges, which are
paid by both the buyer and seller
to their respective brokers.

For trade transactions covering

equity and equity-related
products, the maximum
commission rate is 1.5% of the
total transaction cost plus 12%
VAT. The minimum commission
rates depend on the amount of
the transaction.
 ROLE OF PSE
1. PSE provides a market of securities. It provides a media
through which securities can be bought and sold.
2. Stock exchange enhances share price discovery through
the interaction of demand and supply forces on the
trading floor.
3. Stock exchange share index acts as an indicator of
economic performance.
-n
4. Stock exchange allows the provision
n of information both to
the investors and the industry. This information is for
investors' decisions.
5. It enhances the transfer of share ownership among
investors through the financial facilitation role played by
the brokers.
There are four dates to know when it comes to
companies' dividends:

-n
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
CUM-DIVIDEND AND EX-DIVIDEND
These prices are quoted when the company that has declared
dividends has not paid the price per share.
If the sellers offer the same cum-dividend then it means that the
-n
buyer will get both shares nto be sold and dividends declared on it.
A cum dividend is more expensive as compared to an ex-
dividend share.
Ex-Dividend-The buyer only gets the share sold. The dividend
declared on the share belongs to the seller.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
CUM-RIGHTS AND EX-RIGHTS
These prices are quoted where a company has declared a right
issue.
If the sellers have offered to sell his share cum-right, it means
that the buyer will be entitled
n
not only to receive
-n shares being
purchased but also to rights declared not yet issued.
If the seller sold his shares ex-right it means that the buyer will
only receive the original shares and the sellers will not be entitled
to receive each right issue on share.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
CUM-ALL and EX-ALL
Cum-all means with dividends, with bonuses, or with
rights. The purchaser of the security will be entitled to
dividends: and declared bonus shares, and
-n
has the right
n
to subscribe for additional shares. The share price will thus
reflect this additional value otherwise; the share will sell at
an ex-all price.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
INSIDER TRADING
It constitutes the use of
confidential information about
a listed company that is not yet
made public to take advantage
n
-n

of himself or the other person

connected directly or indirectly
with the company.
TERMINOLOGIES USED IN THE
STOCK EXCHANGE

ACTIVE SECURITIES
These are securities which
are most frequently
-n
traded at the stock
n
exchange.

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 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
BID AND OFFER PRICE
A BID IS THE HIGHEST PRICE A
SECURITY PURCHASER WILL BE
WILLING TO PURCHASE THE
SECURITY WHEREAS OFFER -n
n
PRICE IS PRICE AT WHICH THE
SELLER IS WILLING TO SELL THE
SECURITY.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
ODD LOTS MARKET CAPITALIZATION
This arises when the number This is the market value of a
of shares falls below the company and its market
stipulated limit in a NSE the price at a specified period.
-n
minimum number is 100
n

shares.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
FUTURES AND OPTIONS
A FUTURE is a contractual agreement entered between
two parties where one party promises to provide a
security and the other party promises to buy the
security at some time in the future. A future
-n leads to an
n
obligation.
OPTIONS give the buyer the right, but not the obligation,
to purchase or sell an asset at a specified price and
date.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
JOBBER
He is a dealer.
He is not an agent but a principal who buys and sells
securities in his own name. The profit he earned is
reffered as JOBBER’S TURN.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
BULLS
Speculators in the market who believe that the main
market movement is upwards and therefore buy
securities now hoping to sell them at a higher price in
the future.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
BEARS
Speculators in the market who believe that the main
market movement is downwards therefore securities
now hoping to buy them back later at a lower price.
 TERMINOLOGIES USED IN THE
STOCK EXCHANGE
STAGS
These are speculators in the market who buy new
shares because they believe that the price set by
issuing company is usually lower than the theoretical
value and when shares are later dealt with in the stock
exchange, the share price will increase and they will be
able to sell them at profit.
 STOCK MARKET EFFICIENCY
WEAK FORM EFFICIENCY SEMI STRONG EFFICIENCY STRONG EFFICIENCY
Current share prices fully Current share prices Security prices reflect all
reflect all the show both the past price the information
information contained in movements and also the available both public
first price movements. publicly available and private at each
Price changes contains information. point in time.
NO INFORMATION about No trading strategies Insider information and
the future price can device trading
movements strategies based on
such information.
 SPECIAL FINANCIAL INSTITUTIONS
COMMERCIAL BANK
Accepts both demand and time deposits, negotiable order
of withdrawal (NOW) and money market deposit accounts.
Make loans directly to borrowers through the financial
markets.
 SPECIAL FINANCIAL INSTITUTIONS
SAVINGS AND LOAN
Similar to a commercial bank except that it may not hold
demand deposits. They lend primarily to individuals and
businesses in the form of real estate mortgage loans.

CREDIT UNION
Savings cooperative societies
Deal primarily in transfer of funds between members.
 SPECIAL FINANCIAL INSTITUTIONS

SAVINGS BANKS
Similar to a savings and loan bank in that it holds
savings, NOW, and money deposit accounts.
Lends or invests funds through financial markets
although some mortgage loans are made to
individuals
 SPECIAL FINANCIAL INSTITUTIONS

LIFE INSURANCE COMPANY

It receives premium payments

and invests them to accumulate
funds to cover future benefit
payments.
 SPECIAL FINANCIAL INSTITUTIONS
PENSION FUND
These are set up so that employees can receive income
after retirement.
Majority of funds is lent or invested via the financial market.
 SPECIAL FINANCIAL INSTITUTIONS
MUTUAL FUND
Pools funds from the sale of shares and uses them to
acquire bonds and stocks of business and governmental
units