Module 3

Working Capital Management, Bank and Nonbank Loan Requirements,

and Basic Long-term Financial Concepts
Topics:

Lesson 1: Working Capital Management

Lesson 2: Banking and Non-Banking Institutions
Lesson 3: Simple and Compound Interest
Lesson 4: Loan Amortization

Lesson 1: Working Capital Management

Working capital management is the proper administration of current assets and

liabilities. Good working capital management enables the firm to pay its financial obligation,
establish good relationships with suppliers and creditors, and improve the earnings of the
company.

A working capital management is important because it can improve the business profit.
It allows the company to pay its financial obligations and leads to the growth and survival.

Current assets like cash, accounts receivable, inventories, and prepaid expenses used
in the operations of the business are called working capital. It means that they can be
converted into cash, sold, or exchanged. The amount of resources used in the operations of
the business can be affected by current liabilities like trade accounts payable.

Net working capital is the difference between current assets and current liabilities.

Net Working capital = Current Assets – Current Liabilities

Example: The total assets of Masipag Corporation amounts to Php 20,000,000.00 and its
total current liabilities amounts to Php 16,000,000.00.

• The working capital of Masipag Corporation is Php 20,000,000.00.

• The net working capital of Masipag Corporation is Php 4,000,000.00
(Php 20,000,000 – Php 16,000,000.00)
Operating Cycle and Cash Conversion Cycle

Operating Cycle = Days of Inventory + Days of Receivable

Where:
Days of Inventory (Inventory Conversion Period) is the average number of days to sell
its inventory.

Days of Receivable (Receivable Conversion Period) is the time it takes to collect cash
from the sale of the inventory.

The cash conversion cycle (CCC) is a metric that expresses the time (measured in
days) it takes for a company to convert its investments in inventory and other resources into
cash flows from sales.

Cash Conversion Cycle = Operating Cycle – Days of Payable

Payable
 Figure 1. The Operating Cycle

The operating cycle is 173 days which means that it is longer to recover its inventory.
A shorter cycle is preferred because it means business is more efficient and has enough cash
to meet financial obligations. The company must find ways to decrease its operating cycle.

Payable

It means that the company takes 149 days to get the cash from its investments in
inventory and accounts receivable.
Working Capital Financing Policies

1. Maturity-matching working capital financing policy

The permanent working capital requirements should be financed by long-term
sources while temporary working capital requirements should be financed by short-
term sources of financing.

2. Aggressive working capital financing policy

Some of the permanent working capital requirements are financed by short-
term sources of financing. Managers use this kind of policy because long-term sources
of funds have a higher cost as compared to short-term sources of financing. By
financing some of the permanent working capital requirements with short-term
sources of financing, the financing cost is minimized, which in turn, improves net
income.
But what is the trade off? Since it is short-term, the debt has to be paid soon
and the company may not yet have enough cash by the time the debt matures. This
refers to liquidity risk and this risk increases with the aggressive working capital
financing policy.

3. Conservative working capital financing policy

There are of the temporary working capital requirements that are financed by
long-term sources of financing.
Some companies use this policy because they don’t want to be stressed too
much and to be focused on other company’s matter. It can also be their management
style. It will be easy for the company to raise funds (Cayanan and Borja, 2017).

To summarize the financing policy, see the table below:

Permanent or fixed working capital refers to the minimum level of current assets
required by a firm to continue the operations of the business and to cover up all current
liabilities.

Temporary working capital is the difference between net working capital and
permanent working capital. It can help the business survive during the slack season.

Temporary working capital = Net working capital – permanent working capital.

Long-term sources of financing include long-term debt like loan from a bank and
equity such as common stock and preferred stock. Short-term sources include short-term
loans from a bank.
Cash Management

Cash management involves the maintenance of a cash and marketable securities

investment level which enables the company to meet its cash requirements and at the same
time, optimize the income of idle funds (Cabrera, 2015). The objectives of cash management
are to meet the financial obligation of the firm and to avoid losses in the normal operation of
the business.

Reasons for Holding Cash

1. Transaction Motive – Cash is needed for the day-to-day operations of the business.
2. Contractual Motive – Some banks require a company to maintain a certain
compensating balance for their deposit accounts and loans.
3. Precautionary Motive – Firms hold cash to be ready in case of unwanted situations
such as slowdown of accounts receivables that may affect the fund for operations.
4. Speculative Motive – A company holds cash for other investment opportunities.

Cash budget is used in determining the cash needs of the company. It shows the
projected cash receipts and cash disbursements for a particular period of time. (Cash budget
was discussed in Module 2)

Receivables Management

Providing credits to a customer is one way of increasing sales and gaining additional
customers. Properly managing the accounts receivable lets the company continue its
operations. To minimize loss from accounts receivable, the customer must be given credit
terms and credit evaluation must likewise be done.

The following 5C’s of credit can be used in credit evaluation.

1. Character – is the borrower’s willingness to pay the loan.

2. Capacity – is the borrower’s ability to pay the loan.
3. Capital – is the borrower’s financial resources.
4. Collateral – is the borrower’s security pledge for the loan payment.
5. Condition – is the current economic or business conditions.

Inventory Management

Inventory is the stocks of the product the business is selling and the parts or raw materials
that made up the product.
Inventory management is very important for manufacturing and merchandising companies
especially companies with perishable products. There should be a sufficient number of
inventories to secure the smooth operations of the business.

The following are the list of internal controls that management should consider in to protect
their inventories.
 1. Separating the custodial functions from recording functions. The company should
not allow the assignment of custodial functions from recording functions to one person
to avoid manipulation of records.
2. Aging of inventories. It allows the company to decide what to do with slow moving
items. For example, they can use bundling or buy one take promo.
3. ABC Analysis. This approach categorizes the inventories according to their values. A
is considered the most important inventory or with the highest values, B is considered
the average item and C is the least important or has lower value.

Lesson 2: Banking and Non-Banking Institutions

Banks are financial institutions that accept deposits from or offer loans to an
individual or entity. Here are some examples of banks from the website of Bangko Sentral ng
Pilipinas (www.bsp.gov.ph);
a. Banco De Oro (BDO),
b. Bank of the Philippine Islands (BPI),
c. Land Bank of the Philippines (LBP), to name a few.

Source: https://www.bsp.gov.ph/SitePages/FinancialStability/DirBanksFIList.aspx

Nonbanking institution, on the other hand, offers bank-like services but cannot
accept deposits due to absence of banking license. Examples of nonbanking institutions are
insurance companies, currency exchange, microloan organizations and pawnshops (The
World Bank Group 2020).

Insurance companies offer transfer of risk transactions. In the event of uncertain loss
of the business, insurance may cover the loss for them. Government owned insurance
providers are GSIS and SSS, and private insurance providers like Sun Life, Metrobank AXA,
BPI PhilAm Life are listed in the Insurance Commission (Insurance Commission 2018).

Currency exchange is an industry of buying and selling currencies. Examples of

financial institutions listed in BSP Money Service Business are Western Union, Cebuana
Lhuillier, Mlhuillier, Villarica Pawnshop and many other local forex businesses (BSP-List of
Money Sevice Business 2020).

Microloan organizations are lending companies or organizations that usually offer

small credits to individual or business. These organizations help small businesses to fund
their short-term finances with less requirements. Examples of microloan organizations (also
called microfinancing) are the local cooperatives and lending or semi-lending companies like
Home Credit, GCash, Paymaya and the like. These companies are found in the List of BSP
Supervised Electronic Money Issuers (Bangko Sentral ng Pilipinas 2020)

Pawnshops are institutions that offer quick cash loans or “sanla”. The process is too
simple that a pawner offers a collateral in the form of jewelry (gold, silver, diamond and other
precious metals or stones) to loan money. Examples of these pawnshops listed in the BSP
(List of BSP-Supervised Pawnshops 2020) are Cebuana Lhuillier, MLhuillier, Palawan
Express and Villarica Pawnshop.
 In the Philippines, the regulatory agency governing the conducts of financial
institutions, whether bank or nonbank, is the Bangko Sentral ng Pilipinas (BSP). BSP
regulates these financial institutions by providing policy directions in the general use of
money, banking, and credit (BSP Overview of Functions and Operations 2015). Thus, bank
protocols, especially on information gathering of a client’s personal and financial information,
is ruled by BSP abiding the rules of Anti Money Laundering Act (AMLA).

The following examples were cited for education purposes only.

Loan Requirements of Banks and Nonbanking Institutions

At some point, a business may consider finding an outsource of funds to finance its
operations. Depending on the amount needed, business relies on financial institutions
whether banks or nonbanks, and this amount of credits may require certain requirements
that can range from financial statements, legal/personal documents, or/and property
collaterals.

Business loans can be used in different purposes and whether these funds are used
for short-term or long-term. The loan can be payable in longer terms, example, up to 30 years.
The range of credit offered to a client can be as much amount but will depend on the collateral
he/she submitted. In banks, collaterals are in the form of real properties like land or house
and lot. The business may have to submit the land title as a requirement. The purpose of the
loan should be clear because bank requirements may differ from one purpose to another.
Example of these purposes are for franchising, purchase of new equipment, expansion, or
construction and for establishing a new business. They may even require business
registrations, depending on the type of business: single proprietor, partnership, or
corporation. Banks assess more loan requirements because they are more concerned with
the business’ capacity and ability to pay. Collective term for these loan purposes is Business
Loan or Small-Medium Enterprise (SME) Loan.

On the other hand, nonbanking institutions also provide loans but unlike banks, they
have lighter loan requirements. They may offer flexible amounts to be loaned with minimum
to no collateral acceptance. Under a microloan, for example, a business may apply for a loan
and be approved onsite without the need to disclose the purpose of taking the loan. However,
they have higher interest rates compared to banks. They also have shorter payable period.
The worst can happen that when a business fails, one can be indebted under such big
interest.

Whether loans are applied in banks or nonbanks, a business’ financial structure and
planning should always be monitored. Take loan amounts that are only necessary for a
project and assess the impact of amortization payment to the business. There are certain
banks which also offer up to P5M without collateral under certain conditions and subject for
approval. These banking and nonbanking institutions have different mechanisms on how to
attract potential clients. Thus, background checking is a business’ preventive tool to minimize
the risk of falling into deep interest payment. Financial analysis, financial ratios and budget
preparations are some tools that can help business utilize its funds wisely.

Below are the loan requirements of banks and nonbanking institutions.

Loan Requirements of Banks

a. Application form – is the details gathered in this form refers to your personal data,
income sources and credibility.
b. Valid personal identification documents – are supporting documents that backup the
data presented in the application form. IDs are classified as primary and secondary,
depending on the bank’s list of IDs. Primary IDs usually are government-issued, photo
bearing ID.
c. Financial statements – is usually presented to support credibility of the entity applying
for a loan. The purpose of the loan and/or attractive financial leverage can help ease
the application process.
d. Bank statements – are client record of bank transactions which is used to see the
liquidity of cash flow of the business.
e. Certificate of business registration – refers to the overall legality of the business
organization and its operations. Registration may come from Bureau of Internal
Revenue (BIR), Mayor’s Permit, Department of Trade and Industry (DTI), Securities and
Exchange Commission (SEC), to name a few.
f. Company profile – may be presented in business proposal form indicating the profile
of the business, purpose of the loan, amount to be loaned and/or the return
projections.
g. Collateral documents - include land title, tax declaration, vicinity map, and special
power of attorney (if applicable).

Loan Requirements of Nonbanking Institutions

a. Application form – refers to your personal data, income sources and credibility.
b. Valid personal identification documents – are IDs required in nonbanking institutions
which are classified into primary and secondary which usually require more
identification requirements in loans of big amounts.
c. Credit information/collateral file – are documents offered by the client submitted to and
held by a Custodian.
d. Credit investigation – may be required to determine the credit standing of the applicant
and the fair market value of the collateral being offered.
Loan Application Flow Chart (Yumang, et al. 2016)

Figure 2: Flow Chart of Loan Application

(Source: Exploring Small Business and Personal Finance)

As seen in the flow chart, a borrower will accomplish an application form which
contains personal and business details. Upon submission, the creditor will conduct an
interview for a background check to an applicant regarding his/her credibility, capacity, and
ability to pay. The creditor will request additional requirement, if applicable. If requirements
are met and the application is of good will, the creditor will approve the loan or will be declined
if otherwise.
Lesson 3: Simple and Compound Interest

Businesses and individuals borrow money if in need of cash. When they borrow money,
they incur debt. The lender earns money through interest and the borrower gets the money
he needs but in return, he needs to pay the money he borrowed plus the interest.

What is the time value of money?

The time value of money (TVM) is the concept that money you have now is worth more
than the identical sum in the future due to its potential earning capacity. This core principle
of finance holds that provided money can earn interest, any amount of money is worth more
the sooner it is received. (Investopedia)

People invest their money to receive returns in the future. The time value concept helps
individuals or businesses to analyze what will be the value of money in the present and in
the future.

The present value is the original amount borrowed, the future value is the principal
plus the total interest earned over a stated period, the interest is the amount of money paid
for the use of borrowed money. Present value and future value are both involved in the time
value of money. Both consider three factors: principal, interest rate, and time.

Simple Interest

Simple interest is computed based on the principal amount (original amount) and
based on the annual time. It is computed by multiplying together the principal, rate, and
time.

I = Prt

Where: I = simple interest

P = principal
r = interest rate
t = time
To find the future value (maturity value) at the end of the term, add the principal
amount and the interest earned.

FV = P + I or FV = P (1+rt)

Example 1: You invested Php 20,000.00 for three years at 5% simple interest rate. How much
will you get after three years?

Solution:

Given: P = Php 20,000.00 r = 5 % or .05 t = 3 years

I = Php 20,000.00 x .05 x 3

= Php 3,000.00

FV = Php 20,000.00 + Php 3,000.00

= Php 23,000.00
 Figure 4. Growth Value Using Simple Interest

Example 2: Alex paid Php 1,537.50 with a loan made 3 months before at 10% simple interest.
Find the principal amount of the loan and the interest generated.

Solution:

Given: FV = Php 1,537.50 r = 10 % or .1 t = 3 months = 3/12 = .25

Example 3: The interest on a loan of Php 20,000.00 is Php 3,200.00. If the rate is 8%, when
is the loan due?

Solution:

Given: P = Php 20,000.00 r = 8 % or .08 I = Php 3,200.00

Example 4: Determine the simple interest rate if an investment of Php 25,000.00 accumulates
Php 27,625.00 in 18 months.

Solution:

Given: P = Php 25,000.00 FV = Php 27,625.00 t = 18 months = 1.5 years

Compound Interest

Compound interest is simply earning interest on interest. It means that the interest
earned is added to the principal, and the new principal draws interests.

Where: FV = future value

P = principal
r = interest rate
t = time
Example 1: You invested Php 20,000.00 for three years at 5% compound interest rate. How
much will you get after three years?

Solution:

Given: P = Php 20,000.00 r = 5 % or .05 t = 3 years

Figure 5. Growth Value Using Compound Interest

Example 2: Your father paid Php 176,234.17 with a loan made 5 years ago at 12% compound
interest. What is the principal amount of the loan and the interest generated?

Solution:

Given: FV = Php 176,234.17 r = 12 % or .12 t = 5 years

 Table 3. Example of Nominal Rates

Example 1: Find the maturity value and interest if Php 15,000.00 is deposited in a bank at
3% interest compounded quarterly for five years.

Solution:

Given: P = Php 15,000.00 r = 12 % or .12 t = 5 years m = 4

Simple Interest versus Compound Interest

Simple interest is the interest paid on the initial principal only, while compound interest
is the interest paid on both the principal and the amount of interest accumulated in prior
periods.

Using the previous example, let us compare simple and compound interest. What did
you notice with the principal amount and the interest amount? In simple interest, the interest
is earned on the initial principal only, but in compound interest, the interest is earned on
both the principal and the amount of interest accumulated in previous periods.

Table 4. Simple Interest versus Compound Interest

Lesson 4: Loan Amortization

A loan is the sum of money borrowed that is expected to be paid back with interest.
An amortization is paying the debt with regular payments. A housing loan is an example of
an amortizing loan that requires the borrower to pay. Payments of loans can be annually,
semi-annually, quarterly, or monthly. A bond is a form of loan that can be traded in through
the Philippine Dealing and Exchange (PDEX) System.

When debts are paid using the amortization method, it is important to know how much
interest is paid and how much money is reduced in the principal borrowed. This can be seen
in an amortization schedule or table.

What is an annuity?

An annuity is a series of payments required for a specific number of periods. An annuity

due is when payments are due at the beginning of each payment period. When the payment
appears at the end of each period it is called an ordinary annuity. The present value of an
annuity is computed as:
Example: Find the present value of an annuity if the bank requires Anna to pay Php 10,000.00
at 10% compounded semi-annually for five years.

Remember those interest payments can be paid annually, semi-annually, quarterly, or

monthly, so you have to adjust the interest rates and time accordingly.
Equal Principal Repayments

Example 1:

On January 31, 2020, Matapat Company made a loan of Php 2,400,000.00 from Bank C at
the rate of 8% a year. The loan is paid Php 400,000.00 every December 31 and June 30 until
the full amount is paid.

Table 1. Amortization Table for Php 2,400,000.00

The following are the steps in constructing the amortization table for equal principal
repayments.

1. Find the interest by multiplying the interest rate with the outstanding balance.

I = Php 2,400,000.00 x 8% x (6/12)

= Php 96,000.00
It is 6/12 because the payment is every six months.

2. Find the payment by adding the principal payment with the interest computed.

Payment = Principal + Interest

= Php 400,000.00 + Php 96,000.00
= Php 496,000.00
The payment for June 30, 2020 is Php 496,000.00.

3. Subtract the principal payment from the principal balance.

Php 2,400, 000.00 – Php 400,000.00

= Php 2,000, 000.00
4. Repeat the process up to the last period (time).
Php 2,000, 000.00 x 8% x (6/12) = Php 80,000.00
Php 400,000 + Php 80,000.00 = Php 480,000.00
Php 2,000, 000.00 – Php 400,000.00 = Php 1,600,000.00

The payment for December 31, 2020 is Php 1,600,000.00. Continue until the principal
balance reaches zero.
 The amortization schedule shows that as the principal balances decrease, the
total payment and interest payments also decrease.

Example 1: Let us assume that Matapat Company made a loan of Php 2,400,000.00 to be
paid in equal payments for 3 years. The interest rate is 8% a year compounded semi-annually.
The table shows the company’s amortization every six months.

Table 2. Amortization Table for Php 2,400,000.00 (Equal Regular Payments)

The following are the steps in constructing the amortization table.

1. Find the payment at the end of the period by using the formula:

Solution:
Given: Period: 6 (3 years, semi-annually) r: 4% (8%/2)
Present Value of Annuity
C=
PVIFA
Php 2,400,000.00
C=
5.242137

C = Php 457,828.55

2. Find the interest on the first period by multiplying the interest rate with the loan.

I = Php 2,400, 000.00 x .04

 = Php 96,000.00

Note: 4% is used as interest rate because it is compounded semi-annually.

3. Subtract the interest from the payment to get the principal payment.
Principal Payment = Php 457,828.55 – Php 96,000.00
= Php 361,828.55

4. Find the outstanding balance at the end of each period. Subtract the principal
payment from the previous outstanding balance.
Outstanding Balance = Php 2,400,000.00 – Php 361,828.55
= Php 2,038,171.45
5. Repeat steps 1, 2, 3 & 4 to compute for the payment at the end of the period, interest
rate, principal payment, and outstanding balance for the second to the last period. You
may refer to Table 2.