MSL

WORKING CAPITAL RISK

→ Working Capital (or short-term financial) → the probability that a firm will be unable
management is the management of to pay its bills as they come due.
current assets and current liabilities.
→ Management of the daily activities of the
business. WORKING CAPITAL POLICY
→ Items that move on a day-to-day basis.
→ Current Assets → refers to the level of current assets
o Inventory, accounts receivable invested to attain the desired sales
o Marketable securities level.
o Cash → The choice of policy depends on factors
→ Current Liabilities such as risk, profitability, and liquidity.
o Notes payable 1. AGGRESSIVE OR RESTRICTED
o Accruals
o Accounts payable → Companies that adopt aggressive
working capital tend to have a very low
𝐺𝑟𝑜𝑠𝑠 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 level of current assets thereby lesser
𝑁𝑒𝑡 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 need for short-term financing, resulting
= 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 in low working capital.
− 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 → Companies using this policy have high
profitability but are exposed to liquidity
risk
IMPORTANCE OF WORKING CAPITAL 2. CONSERVATIVE OR RELAXED
MANAGEMENT
→ Companies that adopt Conservative
1. Working Capital comprises a large policy tend to have a higher level of
portion of the firm’s total assets. current assets thereby greater need for
2. The financial manager has considerable short-term financing.
responsibilities and control in managing → This increase financing cost thus
the level of current assets and current lowering profitability or ROI. Companies
liabilities. using this policy trade off profitability to
3. Working Capital management directly attain liquidity.
affects the firm’s long-term growth and → The risk exposure is very low to virtually
survival because higher levels of current none
assets are needed to support production
and sales growth. 3. MODERATE OR MATURITY/MATCHING
4. Liquidity and profitability are likewise OR HEDGING
directly affected by Working Capital
→ Moderate policy is a balance between
Management.
the Aggressive and Conservative.
→ Without sufficient liquidity, a firm may be
→ It combines the features of both policies.
unable to pay its liabilities as they
→ Some level of profitability is given-up to
mature.
attain sustainability.
→ The firm’s profitability is also affected
→ Overall profitability is between the two
because current assets must be
policies.
financed, and financing involves interest
→ The risk is lower than Aggressive but
expense.
higher that Conservative
→ The management is to ensure that the
firm has adequate working capital to run
its business operations smoothly.
→ It should have neither excess working CASH CONVERSION CYCLE (CCC)
capital nor inadequate working capital. → Measures the length of time required for
a company to convert cash invested in
its operations to cash received as a
PROFITABILITY result of its operations
→ Measures the time from when a
→ the relationship between revenues and
company pays cash for its inventory
costs generated by using the firm’s
until it receives cash for its inventory
assets- both current and fixed- in
→ The longer the cash conversion cycle
productive activities.
the more cash the company will need to
→ A firm can increase its profits by (1)
finance itself
increasing revenues or (2) decreasing
costs.
MSL

𝐶𝑂𝑁𝑉𝐸𝑅𝑆𝐼𝑂𝑁 𝐶𝑌𝐶𝐿𝐸 CONSERVATIVE FUNDING STRATEGY

= 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑂 + 𝐴𝑅 𝑇𝑂
→ A funding strategy under which the firm
− 𝐴𝑃 𝑇𝑂
funds both its seasonal and its
permanent requirements with long-term
debt.
CALCULATING CCC
Cost of short-term financing
OPERATING CYCLE (OC) Add: Cost of long-term financing
→ The time from the beginning of the Less: Earnings on surplus balances
Total cost of conservative strategy
production process to collection of cash
from the sale of the finished products.
→ Encompasses 2 major short-term asset STRATEGIES FOR MANAGING THE CCC
categories:
o Average Age of Inventory (AAI) 1. Turn over inventory as quickly as
o Average Collection Period (ACP) possible without stockouts that result in lost
sales.
𝑂𝐶 = 𝐴𝐴𝐼 + 𝐴𝐶𝑃
2. Collect AR as quickly as possible without
→ However, the process of producing and losing sales from high pressure collection
selling a product also includes the techniques.
purchase of production inputs (raw
3. Manage mail, processing, and clearing
materials) on account, which results in
time to reduce them when colleting from
accounts payable.
customers and to increase them when paying
→ Ap reduce the number of days a firm’s
suppliers.
resources are tied up in the operating
cycle. 4. Pay AP as slowly as possible without
→ The time it takes to pay the AP, damaging the firm’s credit rating or its
measured in days, is the average relationship with suppliers.
payment period (APP).
𝐶𝐶𝐶 = 𝑂𝐶 − 𝐴𝑃𝑃
INVENTORY MANAGEMENT
→ Summary:
→ The objective is to turn over inventory as
𝐶𝐶𝐶 = 𝐴𝐴𝐼 + 𝐴𝐶𝑃 − 𝐴𝑃𝑃 quickly as possible without losing sales
from stockouts.
WC
MEASURE
FORMULA DESCRIPTION → According to Investopedia, refers to the
𝟑𝟔𝟎 The no. of days it takes to process of ordering, storing, using and
AAI
𝑰𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝑻𝑶 sell the inventory
𝟑𝟔𝟎 The no. of days to collect selling a company’s inventory.
ACP
𝑨𝑹 𝑻𝑶 the receivables → Process of tracking goods and materials
𝟑𝟔𝟎 The no. of day it takes to
APP
𝑨𝑷 𝑻𝑶 pay suppliers used by a business to produce or sell
OC 𝑨𝑨𝑰 + 𝑨𝑨𝑹
The no. of days it takes to products.
convert inventory into cash
Similar to OC, except, it
accounts for the fact that
the company doesn’t have
CCC 𝑨𝑨𝑰 + 𝑨𝑪𝑷 + 𝑨𝑷𝑷 to pay cash for the 4 COMMON TECHNIQUES IN MANAGING
inventory upfront; suppliers INVENTORY
are financing some of the
inventory
1. ABC SYSTEM

→ inventory management technique that

AGGRESSIVE VS CONSERVATIVE
divides inventory into three groups—A,
SEASONAL FUNDING STRATEGIES
B, and C, in descending order of
AGGRESSIVE FUNDING STRATEGY importance and level of monitoring—on
the basis of the dollar investment in
→ a funding strategy in which the firm each.
funds its seasonal requirements with
short-term debt and its permanent INVENTORY CLASS
requirements with long-term debt. A B C
High Meet the
Cost of short-term financing Money value Low value
value value
Add: Cost of long-term financing Quality of Low to
Less: Earnings on surplus balances Very strict Strict
control strict
Total cost of aggressive strategy Inventory Relatively
Slow Fast
movement fast
Level of
Low Moderate High
safety stock
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Quality of Best determine when orders should be

Average Fair
personal available placed for various items on a product’s
Quality of Highly bill of materials.
Error free Reliable
records reliable → MRP uses information from the bill of
Replacement Can be materials (BOM), to calculate the
ASAP Normal
time long required materials and when they will be
Inventory needed in the manufacturing process.
Low Average High
turnover
→ The BOM is a hierarchical list of all the
materials, subassemblies and other
ECONOMIC ORDER QUANTITY (EOQ) components needed to make a product,
along with their quantities.
→ According to investopedia, this model is → Manufacturing resource planning II
the ideal or three quantity a company (MRP II) – sophisticated computerized
should purchase to minimize inventory system that integrates data from
costs such as carrying cost and order numerous areas.
cost. → Enterprise resource planning (ERP) –
computerized system that electronically
2 × 𝐴𝐷 × 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑂𝑟𝑑𝑒𝑟 integrates external information about the
𝐸𝑂𝑄 = √
𝑎𝑛𝑛𝑢𝑎𝑙 𝐶𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 firm’s suppliers and customers.
→ Advantages:
o Streamlined inventory
JUST-IN-TIME (JIT) management
o Enhanced production scheduling
→ Inventory management technique that o Cost optimization
minimizes inventory investment by o Improved coordination across
having materials arrive at exactly the departments
time they are needed for production. o Timely order fulfillment
→ The goal is to manufacturing efficiency. o Accurate demand forecasting
→ JIT is also sometimes referred to as → Disadvantages:
“lean manufacturing” or “pull-based o Implementation costs
production”. o Data accuracy dependency
→ For JIT manufacturing to succeed, o Overemphasis on forecasting
companies must have steady o Rigidity in handling changes
production, high-quality workmanship,
glitch-free plant machinery, and reliable
suppliers. ACCOUNTS RECEIVABLE MANAGEMENT
→ Reorder Point: point at which to reorder
inventory → The process of monitoring and
controlling money customers owe to a
𝑅𝑂𝑃 = 𝐷𝑎𝑦𝑠 𝑜𝑓 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 × 𝐷𝑎𝑖𝑙𝑦 𝑢𝑠𝑎𝑔𝑒 business for goods or services
purchased on credit.
Safety stock – extra inventory
o
that is held to prevent stockouts → Accounts receivable consists of money
of important items owed to a firm for goods and services
sold on credit. This type of credit
→ Advantages:
basically takes two forms:
o Reduce storage costs
o Trade or commercial credit –
o Ties up less working capital
credit which the firm extends to
o Lowers loss risk
other firms.
o Reduce lead times
o Consumer or retail credit – credit
o Improved efficiency
which the firm extends to its final
→ Disadvantages:
customer.
o Increases risk of stockouts
→ Objective:
o Less pricing flexibility
o To collect accounts receivable as
o Missed opportunities
quickly as possible without losing
sales from high-pressure
collection techniques.
MATERIAL REQUIREMENTS PLANNING
(MRP) CREDIT POLICY

→ Inventory management technique that → a set of guidelines for extending credit to

applies EOQ concepts and a computer customer.
to compare production needs to → Credit Policy generally covers the
available inventory balances and following variables:
MSL

o Credit standards CASH DISCOUNT PERIOD

o Credit terms
o Credit monitoring → The number of days that the cash
discount is valid following the start of the
CREDIT STANDARDS credit period.
→ refer to minimum financial strength of CREDIT PERIOD
acceptable credit customer and the
amount available to different customer. → The duration in days from the start of
the credit period until the account is paid
FIVE C’S OF CREDIT in full.
1. Character: the applicant’s record of meeting CREDIT MONITORING
past obligations
→ The continuous monitoring of a
2. Capacity: the applicant’s ability to repay the company's accounts receivable to
requested credit. ascertain whether clients are making
payments in accordance with the
3. Capital: the applicant’s debt relative to equity.
specified credit conditions.
4. Collateral: the amount of assets that
AVERAGE COLLECTION PERIOD
applicant has available for use in securing the
credit. → It is the average number of days on
which credit sales are exceptionally
5. Conditions: current general and industry-
high.
specific economic conditions and any unique
conditions surrounding a specific transaction. → The average collection period consists
of two parts:
MARGINAL OR INCREMENTAL ANALYSIS o the amount of time from the sale
OF CREDIT POLICIES till the customer sends the
money, and
→ performed in terms of a systematic o the amount of time it takes to
comparison of the incremental returns
receive, handle, and collect the
and the incremental costs resulting from payment once the consumer
a change in the firm’s credit policy. sends it.
→ The decision concerning the change in
credit policy is made using the following 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑
rules: 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
=
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆𝑎𝑙𝑒𝑠 𝑝𝑒𝑟 𝐷𝑎𝑦
Incremental Profit Then accept the
Contribution > change in credit AGING OF ACCOUNTS RECEIVABLE
Incremental Cost policy
Incremental Profit Then reject the → A form of credit monitoring that divides
Contribution < change in credit accounts receivable into groups
Incremental Cost policy according to when they were created; it
Incremental Profit Then be shows the percentages of the total
Contribution = indifferent to the amount of accounts receivable that have
Incremental Cost change in credit been past due for a specific amount of
policy time.

CREDIT TERMS & CREDT MONITORING

MANAGEMENT OF RECEIPTS &
CREDIT TERMS DISBURSEMENTS
→ The conditions of sale for clients who → The receipt, processing, and collection
have been given credit by the company time for the firm, both from its customers
are known as credit terms. and to its suppliers, is the focus of
→ Under terms of net 30, the customer has receipts and disbursements
thirty days to pay the entire amount due management.
in voice from the start of the credit
period, which is usually the end of the FLOAT
month or the date of the invoice.
→ refers to funds that have been sent by
CASH DISCOUNT the payer but are not yet usable funds to
the payee lengthens both the firm's
→ A credit customer may be eligible for a average collection period and its
percentage reduction from the purchase average payment period.
price if they settle their account within a
certain amount of time.
MSL

THREE COMPONENT PARTS: LOCKBOX BANK & OTHER COLLECTING

BANKS TO THE CONCENTRATION BANK
MAIL FLOAT It is the time delay between
when payment is placed in → Depository Transfer Check (DTC)
the mail and when it is → ACH (automated clearinghouse) transfer
received → Wire Transfer
PROCESSING It is the time between
FLOAT receipt of the payment and
its deposit into the firm’s
account
CLEARING It is the time between
FLOAT deposit of the payment and
when spendable funds
become available to the firm

SPEEDING UP COLLECTIONS

→ Lockbox system
→ Pre-authorized checks
→ Pre-authorized Debit/Checks charges
→ Remote Deposit
→ Concentration banking
→ Depository Transfer Checks
→ Wire Transfer

SLOWING DOWN PAYMENT

→ The concept of float is an important

component of an accounting firm's
average payment period.
→ In this case, the float is advantageous
for the firm.
→ By increasing all three components of its
payment float, the firm can benefit.
TYPES OF DISBURSEMENTS
1. CONTROL (USED) DISBURSEMENT

→ stretch payables by paying as late as

possible within the credit period
→ maintain zero balance accounts (ZBA) –
checks are written from special
disbursement accounts having zero-
peso balance (no minimum maintaining
cash balance required).
o Funds are automatically
transferred from a master
account when a check drawn
from a ZBA is presented
→ play the float – increase the positive
float
→ less frequent payroll and schedule
issuance of checks to the suppliers
2. CASH CONCENTRATION

→ Cash concentration is the process used

by the firm to bring lockbox and other
deposits together into one bank, often
called the concentration bank.
VARIETY OF MECHANISMS FOR
TRANSFERRING CASH FROM THE