Working Capital Management

It is the management of current assets and liabilities. To achieve a balance between profitability and risk that contributes positively to the firms value.

Working Capital Management

Current assets are the least profitable assets of the company (T/F)

True

The higher the risk, the higher the return.

Risk and return trade-off

The yield curve of risk and return trade-off is upward sloping (T/F)

True

Profitability is directly related to liquidity (T/F)

False

It is the length of time in which the firm purchase inventories, sell it and receive cash from sale

Operating Cycle

Operating Cycle formula

Days inventory + Days A/R

It is the length time between paying for working capital and collecting cash from sale of inventory

Cash Conversion Cycle

Cash Conversion Cycle Formula

Operating Cyle - Days A/P

Goal of the company in cash conversion cyle:

Shorten the cash conversion cycle

The basis for how much the company should invest in working capital.

Cash conversion cycle

2 Ways on how to shorten the cash conversion cycle

• Lower the days inventory or days accounts receivable

• Increase the days accounts payable

Pikachu Corp., a leading producer of barbie dolls, turns out 3,000 dolls a day at a cost of P250 per doll for prime cost. It takes the firm 20 days to convert raw materials into barbie dolls. Pikachu allows its customers 25 days in which to pay for the dolls, and then it pays suppliers on a 15-day basis.

How long is Pikachu’s operating cycle?

45 days
Op. Cycle = Days Inv. + Days A/R
= 20 Days + 25 Days

Pikachu Corp., a leading producer of barbie dolls, turns out 3,000 dolls a day at a cost of P250 per doll for prime cost. It takes the firm 20 days to convert raw materials into barbie dolls. Pikachu allows its customers 25 days in which to pay for the dolls, and then it pays suppliers on a 15-day basis.

How long is Pikachu’s cash conversion cycle?

30 Days
Cash Conversion Cycle = Op. Days - Days A/P

45 Days - 15 Days

Pikachu Corp., a leading producer of barbie dolls, turns out 3,000 dolls a day at a cost of P250 per doll for prime cost. It takes the firm 20 days to convert raw materials into barbie dolls. Pikachu allows its customers 25 days in which to pay for the dolls, and then it pays suppliers on a 15-day basis.

Assuming that the production of dolls is steady, what amount of working capital must Pickachu finance?

P22,500,000

= 3,000 dolls a day x P250/per doll x 30 days (Cash conversion)

A type of working capital policy that has a very low level of current assets thereby lesser need for short-term financing, resulting to low working capital. Companies using this policy have high profitability but are exposed to liquidity risk. (Konti lang ‘yong utang, konti lang yung financing cost, mataas yung profitability, pero wala kang cash (working capital)

Aggressive or Restricted

A type of working capital policy that has a higher level of current assets thereby greater need for short-term financing. This will increase financing cost thus lowering profitability or ROI. Companies using this policy trades-off profitability to attain liquidity. The risk exposure is very low to virtually none. (Marami kang cash, pero wala kang profit kasi ayaw mong mag-invest).

Conservative or Relaxed

A type of working capital policy that is a balance between the Aggressive and Conservative. It combines the features of both policies. Some level of profitability is given-up to attain sustainability. Overall profitability is between the two policies. The risk is lower than Aggressive, but higher than Conservative.

Moderate or Maturity Matching or Hedging

It focuses the length of time between when a company makes payments to its creditors and when a company receives from its customers.

Cash Conversion Cycle

It is the time between cash payment and the point that the cash is in the hands of the payee already available for his disposal.

Float