Finance Chapter 5

8/11/2019 Finance Chapter 5

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CHAPTER V

MANAGEMENT OF WORKING CAPITAL


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NATURE OF WORKING CAPITAL

Working capital is defined as the total firms

investment in current assets used in its day-to-day

operations. Some refer to it as a revolving capital oroperating assets.


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Rationale for the need of working capital

are:

Enable the firm to settle all its maturing obligationson time

Be able to defray all expenses incurred in the

business operations such as salaries, utilities,

rentals, insurance premia, taxes, etc. To replenish inventories within the time frame

To support its credit sales and

Provide for any possible contingencies or

opportunities for investment.


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Factors affecting the required amount of

working capital

The firms term of purchase and sale A firm that purchases its inventories on credit will require a

small amount of working capital

If inventories are acquired on cash basis, a bigger working

capital will be needed The turnover of merchandise inventory

A firm that produces goods that are fast moving item orsaleable ones do not need a bigger working capital

A firm producing slow moving items may require a bigger

working capital Volume of goods on hand to satisfy customers demand

A firm that maintains safety stocks needs a bigger workingcapital than that which do not maintain such stocks


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Factors affecting the required amount of

working capital

The type of business activity A business that requires a big investment in inventories

(manufacturing) requires a much bigger working capital to beable to maintain the needed volume of inventories

Firm like merchandising needs smaller working capital

The turnover of its receivables Collection of receivables within a short period of time means

cash inflows in short period of time thus requiring smallerworking capital

Firm that allows a longer period for the payment of sales oncredit will require a bigger working capital as a support to the

receivables Business influenced by business cycles

A firm that is influenced by the ups and downs of businesscycles, is going to need a bigger working capital, for a certainperiod determined by the firm, production must be increasedthus a need for bigger working capital


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Management of cash

Cash is the most liquid yet the least productive

assets.

It enables payment of obligations when due but

lessens productivity when it is hoarded.

Strategies in cash management are formulated

aiming at two important goals:

1) to make cash available when needed to meet the firms

payments

2) to maintain the least amount of idle cash being held by

the firm.


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There are two assets being regarded as liquid asset:

Cash- is composed of bills and coins that the firmholds in its possession.

Near Cash - its ability to be easily converted into cash

like marketable securities.


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Three reasons for holding cash

To maintain a state of solvency

Solvency is the degree to which the current assets of an

individual or entity exceed the current liabilities of that individualor entity.

ability of a corporation to meet its long-term fixed expenses and

to accomplish long-term expansion and growth

As a precautionary motive

In order to patch up contingencies that are beyond human

control

As a speculative motive

Profit making opportunity for a business firm


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Strategies in cash management

A good financial management involves efficientmanagement of cash. This could be attained byaccelerating cash collections and decelerating cash

disbursements.Accelerating cash collection:

Cash discounts

Concentration banking

Synchronizing cash inflows and cash outflow

Collection from Post dated checks

ATM

Decelerating Cash Disbursement: Stretching payables through PN


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Management of receivables

Receivables are created when a firm sells its productand/or service on credit in the use of credit cards andpurchase orders.

The more credit sales the firm has, the bigger receivablesbe determined as a result of credit sales

With credit policies the granting of credit to its customerswill be subject to existing companys policies: Terms of salesrefers to the time period in which buyers must

pay and the terms of the sale.

Type of customers

Collection procedures Credit standard- a measure of determining those who will be

extended credit facilities or not


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Consequences to credit sales

The consequence of credit is that the capital of

the firm is transformed into an investment in the form

of accounts receivable. When the greater portion of

its sales are on credit, mounting account receivablesas a consequence may create a problem of how

much needed capital should be made available to

support such an accumulation of receivables

originating form credit sales.


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Inventory management

it is necessary in controlling the assets being

produced and sold. At the same time the company

can minimize entailing the cost of producing andmaintaining said goods in its normal course of

operations. The assets that are referred to here are

the raw materials, goods in process, finished goods

and spare parts.

Finance Chapter 5

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