WORKING CAPITAL & CASH MANAGEMENT-1

KEY TAKEAWAYS

A company has negative working capital if the ratio of current assets to liabilities is less than
one. Positive working capital indicates that a company funds its current operations and invests
in future activities and growth. High working capital is not always good. It might indicate that the
business has too much inventory or is not investing its excess cash.

QUESTION: WHAT IS WORKING CAPITAL MANAGEMENT?

It deals with operating activities as they share the profitability and liquidity of the enterprise.

THE OPERATING ACTIVITIES COMPRISE INVESTMENT IN CASH FOR:

● Inventory procurement, manufacture, and loading
● Trade receivables to conserve credit and collection activities products and to manage
the business
● Expenses to distribute
● Marketable securities to manage differences and indecision in the operating cash
requirements

Prepaid expenses, unless material, are not the center of the Working Capital
Management

INVENTORY PROCUREMENT
This is the process of acquiring or buying the goods and materials your business needs.

MANUFACTURE
This is the process of making products from raw materials.

LOADING
This is the process of placing goods onto transportation vehicles (like trucks or ships) to be sent
out to customers or to other locations.

Trade receivables to conserve credit and collection activities Trade receivables are the amounts
customers owe your business for goods or services purchased on credit. To manage these
effectively, you need to conserve credit by being cautious about how
much and to whom you extend credit, ensuring you don't take on too much risk. Additionally,
you should focus on collection activities by actively following up with customers to collect the
payments they owe. This helps maintain your cash flow and keeps your business running
smoothly.

EXPENSES TO DISTRIBUTE PRODUCTS

are the costs associated with getting your products from your business to your customers.
EXPENSES TO MANAGE THE BUSINESS
are the costs needed to run your business on a daily basis.

MARKETABLE SECURITIES TO MANAGE DIFFERENCES AND INDECISION IN THE

OPERATING CASH REQUIREMENTS
Marketable securities are investments like stocks or bonds that a company can easily sell for
cash. Companies keep these securities so they have a quick way to get extra money if their
day-to-day cash needs change or are uncertain. This helps them manage any unexpected
differences or indecision in how much cash they need to operate smoothly.

THE WORKING CAPITAL IS THE WORKING CAPITAL IS FIGURED OUT AS FOLLOWS:

ACCOUNTS AMOUNTS EXPLANATION

Current Assets PX Total short-term investments

to complete the operating
cycle.

Current liabilities x Short-term creditors share in

financing the enterprise’s
operating cycle.

Working capital x Enterprise’s equity in

financing its operating cycle

WORKING CAPITAL WORKING CAPITAL FINANCING POLICIES

1.Matching Policy (also known as Self-Liquidating Policy or Hedging Policy harmonizing the
maturity of a financing resource with an asset’s useful life:

● Short-term assets are financed with short-term liabilities

● Long-term assets are funded by long-term financing resources Long-term assets are
funded by long-term financing resources

2.Conservative (Relaxed) Policy Operations are accompanied with too much working capital; it
involves financing all nearly all asset investments with long-term capital.

3. Aggressive (Restricted) Policy Operations are accompanied on a minimum amount of working

capital; uses short-term liabilities to finance, not only temporary, but also a portion or all of the
permanent current asset requirements

4. Balanced Policy Balanced the trade-off between risk and profitability in a way stable with its
approach toward bearing risk.
Analyze the related trade-off among liquidity risk, interest rate, and return on assets.

SCENARIO Conservative Policy Aggressive Policy

IF Current assets ↑ ↓
AND/OR: Current liabilities ↓ ↑
THEN Working capital ↑ ↓
Default risk ↓ ↑
AND, Return on Net WC ↓ ↑
(Profit/Ave WC)

Current Ratio ↓ ↑
Liquidity risk ↑ ↓

Working Capital Policy Part of Working capital Financed by

Very Conservative Permanent working capital Long-term financing

fluctuating working capital (e.g.bonds payable and share
capital)Long term financing

Moderately Conservative Permanent working capital Long-term financing Partly

fluctuating working capital long-term financing and party
short-term financing

Aggressive Permanent working capital Partly long-term financing

fluctuating working capital and partly short-term
financing Short-term
financing
Working Capital and Cash Management - 2
Cash Management
● The process of monitoring and maintaining cash flow to ensure that a business has
monetary or enough funds in its operation.
● Involves cash inflow and cash outflow.
● It consists of currencies (e.g., coins and bills), checks demand deposits, checking
accounts and cash equivalents that are used for working capital operations

Cash & Cash Equivalents

Cash includes legal tender, bills, coins, checks received but not deposited, and checking and
savings accounts.

Examples of Cash:
● Money Bills and Coins
● Checking Deposits
● Savings Accounts
● Undeposited Receipts

Examples of Money Bills and Coins:

● A currency used as a medium of exchange that is legal tender of Central Bank or
accepted at face value for products and services as well as for savings and the
payment of debt.

Examples of Checking Deposits:

● Refers to Checking accounts that allows an individual or company to deposit money
that can then draw against to pay bills or make purchases for everyday transactions.

Examples of Savings Accounts:

● Refers to a deposit account held at a bank or financial institutions, allowing
individuals and companies to save money while earning interest.

Examples of Undeposited Receipts:

● These are accounts receivables or payments received from customers that have not
yet deposited to the Individual’s or Company’s bank account.

What are Cash Equivalents?

It is usually the most liquid of all assets. The quickest of quick assets, the most current of
current assets. Cash equivalents are any short-term investment securities with maturity
periods of 90 days or less. They include bank certificates of deposit, banker’s acceptances,
Treasury bills, commercial paper, and other money market instruments.

Cash and its equivalents differ from other current assets like marketable securities and
accounts receivable, based on their nature. However, certain marketable securities may
classify as a cash equivalent, depending on the accounting policy of a company.

Examples of Cash Equivalents

The full list of cash equivalents includes the following items in Money Market Funds which
maturity dates that are typically three months or less:
● Commercial Paper
● Treasury Bills
● Bank Certificate of Deposits
● Other liquid investments that mature within three months

Examples of Commercial Paper:

● An unsecured form of promissory note that pays a fixed rate of interest. Typically
issued by large banks or corporations to cover short-term receivables and meet
short-term financial obligations, such as funding for a new project.

Examples of Treasury Bills:

● A short-term financial instrument issued by the government that is backed by a
country's own treasury.
● Considered a low-risk investment which investor runs very little chance of losing
money.

Examples of Bank Certificate of deposit:

● A savings account that holds a fixed amount of money for a fixed period of time,
such as six months, one year, or five years, and in exchange, the issuing bank pays
higher interest

Reasons for holding CASH

● Transaction Purposes
● Compensating Balance Requirements
● Precautionary Reserves
● Potential Investment Opportunities
● Speculation

Factors Affecting Cash Requirement

● Firm’s policy on cash management
● Availability of loans
● Forecasted cash inflow and outflow
● Unpredictable events

1. Firm’s policy on cash management

● Refers to the amount of cash a firm need to cover for a certain period of days of the
business operations.
● Depends on how fast cash is generated by the firm.

1. Firm’s policy on cash management

● Matching Policy
● Conservative (Relaxed) Policy
 ● Aggressive (Restricted) Policy
● Balanced (Moderate) Policy
2. Availability of loans
● Firms with good credit standing may hold a cash balance at low levels without
putting the firm at risk
● Funds are always available when the need arises
3. Forecasted cash inflow and outflow
● Differences between the inflows and outflows are determined by analyzing the
collections and disbursements records of the firm.
● Helps the firm ascertain the proper timing of financing and debt repayment
4. Unpredictable events
● Estimating unpredictable events may save a lot of time and money for the firm
● Not meeting any unpredictable increase in demand of the firm’s products reduces
the opportunity income

Possible Placement for Excess Cash

● Firms with good cash management would know the amount of funds available for
investment as well the length of time it can be invested.
● Having idle funds for a certain period of time is a good source of an Incremental
income.

Here are some of the possible places of investments are the following:
1. Savings and/or current accounts
2.Time deposits
3. Stocks
4. Treasury bills
5. Savings and/or current accounts
6. Time deposits
7. Stocks
8. Treasury bills

1. Savings and/or current accounts

● Bank placements with no holding period
● Interests earned in these kinds of placements are lower than those earned in time
deposits
● Current accounts now bear interests
● Current account is lower than the interest offered by a savings account

2. Time deposits
● Placements with holding period
● Normally taxed at 20% of the interest income
● Earn higher interest than the savings account

3. Stocks
● Shares of stocks traded in the formal stock exchange (brought from stockholders)
● Entail costs which include:
1.Broker's commission
2. Government taxes
 3. Documentary stamp tax

4. Treasury bills
● Short-term obligations issued by the government
● Usually offered with a maturity of 91 days (there are treasury bills that mature in
more than 91 days but less than a year)
● Unique because these are traded on a discount basis that is, it earns interest until
the maturity date.
● The maturity value less the discounted value is the profit earned for investing in
treasury bills,

5. Commercial papers
● These are unsecured promissory notes issued by firms with high credit standings.
● Normally higher than that from the savings account.
● No collateral is offered by firms that issued the commercial papers.
●
6. Improve company benefits
● It might be a great opportunity to shop around for better retirement plans, healthcare,
and educational resources.

7. Reward your employees

Use the surplus to reward your staff with;
● Wage or salary increases,
● Bonuses,
● or Contributions

Not only does this help them feel appreciated, but also improves company morale.

● Controlling Cash Flows

● Controlling cash flows is the main objective of cash management. Over the years,
firms and finance partners alike have been finding ways and means to maximize the
use of cash. Maximizing the use of cash involves minimizing cash outflows and
maximizing cash inflows.

The following tools may be used for controlling cash flows:

1. Synchronizing cash flow

2. Cash Floats on
a. Payment
b. Collections
3. Extending cash payments
4. Availing of cash discounts
5. Optimum transaction size

1. Synchronizing Cash Flow

This involves aligning cash inflows with outflows to ensure they coincide as much as
possible. An accurate forecast of cash flows helps the firm to maintain an optimal cash
balance, which reduces the need for borrowing, lowers interest expenses, and ultimately
maximizes profits.

Example:
A retail business might synchronize its cash inflows from daily sales with its outflows for
inventory purchases. This reduces the likelihood of needing to take out a loan to buy more
inventory.

2. Cash Float
Floats are the differences between a company’s book balance and bank account balance of
the company during a period.
One of the major variable that affects the cash inflows and outflows.

Types of cash floats

● Cash Floats on Payments
● Cash Floats on Collections

● Cash Floats on Payments

The cash float on Payments or Disbursements refers to the delay between when a
company issues a payment (such as a check) and when the funds are actually deducted
from the company’s bank account

● Cash Float on Collections

The cash float on collections refers to the time delay between when a company
receives payment from its customers and when the funds are actually available for use in
the company’s bank account.

Cash Float
Example:
A company might issue a check to a supplier knowing it will take a few days to clear,
allowing the company to use those funds for other purposes during that period.

Types of Floats:
a. Mail Float
The time interval from when a check is issued until it is received by the payee.
b. Processing Float
The time from when the check is received by the payee until it is deposited into the payee's
bank account.
c. Clearing Float
The period from when the check is deposited to when it clears and the funds become
available for use.

3. Extending Cash Payments

Delaying cash outflows as long as possible without incurring penalties can improve a firm's
liquidity position. This involves negotiating longer payment terms with suppliers or
strategically scheduling payments.

Example:
A company may agree with a supplier to pay invoices within 60 days instead of 30. This
extra time allows the company to better manage its cash flow and use the funds for other
business activities.
4. Availing Cash Discounts
Companies can benefit from discounts offered for early payments. By paying early, firms
can reduce costs and improve relationships with suppliers.

Example
A company that pays a $1,000 invoice within 10 days might receive a 2% discount, saving
$20 on that transaction. Over time, these savings can add up significantly.

5. Optimum Transaction Size

Managing the size of cash transactions can reduce transaction costs and optimize cash
use. Larger transactions may benefit from economies of scale, but they must be balanced
with the need for maintaining sufficient liquidity.

Example
A company might choose to buy office supplies in bulk to get a discount, but it must
balance.

Example
A company might choose to buy office supplies in bulk to get a discount, but it must
balance.

1. Playing the 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

1. Playing the float

● The process of taking advantage of the clearing system in the cash float on
payments in order to use the funds in a firm's bank account.
● Firms who knows this technique may able to prolong or remain their funds in an
account and may use it for a certain short period of time before debited it to the
deposited check.
● The firm who practice this must be able to deposit the necessary fund or cash before
the check is cleared. Otherwise, they will incur penalty charge and service charge for
issuing an overdraft check.

2. Payment by draft
● An unconditional order made in writing addressed by one person to another, signed
by the person giving it, requires the receiver to pay on demand or at a fixed or
determinable future time a certain sum of money to order or to the bearer.
● Drawn by bank.
● Commonly use for bigger transaction or large payments.
● Offer payment to the creditor with a security or guarantee.
3. Auto-debit transfer
● One of the services offered by the bank which provides the firm with two or more
accounts to facilitate payments and collections.
● The firm has to maintain a certain amount in their account, normally called average
daily balance.
● When a check issued by the firm is presented to the bank, the amount to be charged
to the current account will be funded automatically by the savings account.
Advantage:
Gives the firm another source of short-term funds and incremental income in the form of
interest

4. Debit transfer
● Done manually, usually at the end of the banking day or early on the next banking
day.
● The amount of funds to be transferred to the current account is determined by the
total of all charges made to the firm.
● It transfers just enough funds to cover the checks presented for payments.
● The amount for disbursements is only transferred once the amount is determined.

5. Stretching of payables
● The process of postponing or extending the payments to suppliers or creditors
beyond the credit due/period.
● Stretching routine might take 30, 45, 60, or 90 days.

ADVANTAGES:
It gives the company more time to pay the bills.
Extends the cash flow.
DISADVANTAGES:
Might result to lower credit line.
Giving up the discounts covered by the purchases.

6. Centralization of disbursements
● Centralization refers to the process in which activities involving planning and
decision making within an organization are concentrated a specific leader or
location.
● Allows companies to monitor and structure payments.
● Firms can select creditors who must be paid first and extend payments to those who
can tolerate delays.

7. Use of statistics to predict the amount of checks issued

● Involves historical and present disbursement of the firm.
● Normally done for payroll and dividend payments.
● The firm can approximate the funds it needs to cover the check issuances based on
past records.
● The firm opens an account exclusively for these disbursements which do not
necessarily cover the entire amount of payroll or dividend payments.
 ● Establishing on the average, the amount of the checks to be presented by its
employees or the beneficiary of the dividends.
RECEIVABLES MANAGEMENT PART 1
WHAT IS RECEIVABLE MANAGEMENT?
-It is a system or process of keeping track of what customers buy from companies on
credit.

KEY TAKEAWAYS:
• Companies that allow customers to purchase goods or services on credit will have
Receivables on their Balance Sheet.
• Receivables are recorded at the time of a sale when a good or service has been delivered
but not yet been paid for.
• Receivables will decrease when payment from customers is received.
•The amount of Receivables estimated to be uncollectible is recorded in an Allowance for
Doubtful Accounts.

WAYS OF ACCELERATING COLLECTION RECEIVABLES :

1. Shorten credit terms
2. Offer special discounts to customers who pay their accounts within a specified period
3. Speed up the mailing time of payments from customers to the firm
4. Minimize float, that is, reduce the time during which payments received by the firm remain
uncollected funds

RECEIVABLES MANAGEMENT STRATEGY

-Extending credit when incremental sales outweigh incremental costs or expanding credit
sales to the point that the marginal cost equals the marginal profit (Cost benefit analysis).

Consequences when relaxing Credit Terms:

-Increase in Credit Sales
-Increase in Accounts Receivable
-Increase in Bad Debts
-Increase in Collections cost
-Increase in Opportunity cost on incremental investment in
Receivables
-Increase in Sales Discounts

Aids in analyzing Receivables:

1. Ratio of receivables to net credit sales
2. Receivable turnover
3. Average collection period
4. Aging of accounts
FACTORS CONSIDERED IN MAKING ACCOUNTS
RECEIVABLE POLICIES
1. Credit Standard

-Consider the following questions: Who (customers) will be granted credit?

How much is the credit limit? Factors to consider in establishing credit
standards - the Five C's of Credit:

Character- customers' willingness to pay

Capacity - customers' ability to generate cash flows
Capital- customers' financial sources (l.e., net worth)
Conditions- current economic or business conditions
Collateral- customers assets pledged to secure debt

2. Credit Terms
- This describes the credit duration and discount given for prompt
payment by customers. The following expenses relating to credit
terms shall be taken into account: cash discounts, credit analysis
and collection costs, bad debt losses and financing costs.

3. Collection Program
- Shortening the average collection period may prevent
excessive investment in receivables (low cost of opportunity)
and excessive loss due to delinquency and defaults. The same
could also lead to loss of customers if applied harshly.

Trade Credit
- Trade Credit is granted to increase the sales volume. Nevertheless, it also involves
spending or through the receivables of the company's accounts. The company's investment
in receivables is the contingent costs generated by the receivable accounts, and not the
volume of reported credit sales.

EXAMPLES:
- If JKL Company's credit sales are P180,000, the collection period is
90 days, and the cost is 75% of the sales price, what are the
average accounts receivable balance and the average investment
in accounts receivable?
Average accounts receivable=

P 180,000
360 × 90 days = P45, 000

Investment in A/R = 45,000 × O.75

= P33,750
Receivables Management Part 2

Companies or firms offer credit to maximize its sales and increase accounts receivables.
This helps the business to acquire more customers, increase customer’s loyalty and generate
more income or revenue. However, offering credits to customers possess a higher risk of more
bad debts accounts or Allowances for doubtful accounts. This is where Credit Policy takes its
place to help the company manage its receivables.

*Other terms for Bad debts accounts:

- Allowances for Doubtful accounts
- Defaulted Debt
- Uncollectable Debt
- Delinquent Accounts

KEY TAKEAWAYS

● Credit policy or control is a business strategy that promotes the selling of goods
or services by extending credit to customers.
● Most businesses try to extend credit to customers with a good credit history so as
to ensure payment of the goods and services.
● Companies draft credit control policies that are either restrictive, moderate, or
liberal.
● Credit control focuses on the following areas: credit period, cash discounts, credit
standards.

CREDIT POLICY
● Treasurer - Responsible for credit and collection functions.
● Credit Policy - A set of guidelines that determines which customers are
extended credit and billed, Set the payment terms, Define the limits, and Outline
the steps or procedures used to deal with delinquent accounts.
 *Setting the Credit Policy is the beginning of the effectiveness in handling
account receivables.
*First, it forms good ties with customers.
*Second, it formulates an efficient collection strategy.

COMPONENTS OF CREDIT POLICY

● Term Credit
- Refers to the terms that indicate when the payment is due, possible
discounts, and any applicable interest or late payment fees. In simpler
explanation, It is the terms set by the company in relation to credits - the
time limits, discounts, interest, or fees you set for the customers'
promise to pay for their merchandise or services received.

*Credit Period - Duration of Credit Sales

*Cash Discounts - given to customers to entice prompt payments.

- Relaxing Term Credit

● Companies may decide to extend the duration of the credit. For
instance, from n/30 days, the firm may decide to change it to n/40
days.This benefits both the company and the customer as the
customer will be enticed to apply for a credit which generates
more sales for the company, and the customer may have a longer
period of time to pay its debt. However, it is expected that the
expenditure will also accumulate or stockpile or increase
alongside receivables and inventories.

- Shortening Credit Period with Discount Offering

● A business may consider providing credit to clients with a higher
than normal risk rating. Rather of offering a longer credit period,
though, the company will sell a shorter term offset by a discount.

● Credit Standard
- Refers to the company’s rules in offering credit sales to customers. This
relates to the financial ability and creditworthiness that a customer needs
to show to apply for credit.
THE FIVE C’S OF CREDIT

1. CHARACTER - Refers to the moral and ethical standard of the

person responsible for paying the loan.
- Past Credit Reports
- Good credit reports have a good credit risk.
2. CAPACITY - Refers to the willingness of the borrower to pay off
the additional credit.
- Determined in financial statements based on the cash
flows available for paying debt obligations.
3. CAPITAL - Refers to the amount of financial capital that the
organization requesting the loan may access.
- Strong capital reflects the applicants resilience to withstand
ups and downs of the market lending rates.
- Assessing through debt-to-equity and the financial
structure of the company.
4. CONDITIONS - Refers to the existing general economic and
industry-specific conditions and any special circumstances
involving a particular transaction.
- Indicators of the applicant’s ability to generate revenue and
repay the debts.
5. COLLATERAL - Consist of customer pledged money. For the
case of default, it also requires the economic value of those
properties.
- Ex. tangible assets such as lands, equipment, machinery,
and buildings or property.
- The better the quality and the greater the amount of the
available assets, the greater the chance for a firm to
recover funds if the applicant defaults.
 ● Collection Policy
The process:
1. Sending a billing statement when the due date is near.
2. If the payment is not received on the due date, a further letter
shall be sent to inform the debtor that his account has not been
paid.
- To ensure the collection of the account due, this can be
either through:
*Phone Calls
*Personal Visits

3. If the balance is not yet paid, the collecting agency shall be

hired by the company to make an aggressive move to collect the
outstanding account.
- A fixed rate plus a certain percentage of the amount to be
collected is normally paid to the collecting agency.

FORMULA FOR SOLVING

= Net credit sales

Accounts Receivables
360

= (Beg. A/R + Credits sales) - (End. A/R +

Cash Collected
Bad Debts)

= Credits sales
Accounts Receivables Turnover
Ave. A/R

= Beg. A/R + End. A/R

Ave. Accounts Receivables
2

= Required collection period X Cost of Sales

Investment in Accounts Receivables
Paid.

Cash Conversion Cycle/ Net Operating = Days sales in inventory + Days Sales in
Cycle Receivables - Days Payment Outstanding.
 = Days sales in inventory + Days sales in
Operating Cycle
Receivables

Net working Capital = Current Assets - Current Liabilities

= ∑ Current ASSETS
or
Gross working Capital
= Cash + Accounts Receivables +
Inventories +Marketable Securities

Sales Budget

= (average accounts receivable balance ÷

Receivables Conversion Period
net credit sales ) x 365

= (Discounts % / 100% - Discounts %) x

Cost of giving up cash discounts
(360/ Final Due date - Discount period)