Mr. Khan, President of Dynamics, Inc. was
shocked to learn that one of the company’s
principal suppliers had just informed the
company that it would no longer supply the firm
with parts needed in their products. The reason
is imply the company’s inability to pay its
obligation on its due dates for quite some time
now, including other suppliers, and that the
reason for the slow payments was a shortage
of cash. Mr. Khan cannot believe and cannot
understand how that happened, were in fact the
company’s sales were terrific, and the profits
break its records in the past. “How can that
happen? How can the company possibly not
have enough cash to pay our bills on time?”
1. How much should we invest in current
assets (cash, accounts receivable,
inventory or temporary investments)?
2. How should we finance such investment?
Short-term Financial Management
1. How much cash should be maintained in the
current, checking, or savings account?
2. How many inventories must be maintained?
3. How long would be the credit terms to old
and new customers?
4. Should the company pay dividend this year
5. Should we borrow or issue equity shares?
1. Hedging principle (rule of self-liquidating debt) provides the
basis for firm’s working capital decisions.
2. Permanent investment in an asset is one which the firm
expects to hold for a period of more than one year.
3. Temporary investment in an asset includes the firm’s
investment in current assets that will be liquidated and not to
be replaced during the year.
4. Spontaneous sources of financing include all those sources
that are available upon demand, such as, trade credits or
accounts payable, or those that arise naturally as a part of
doing business such as wages, interests, taxes payables
5. Temporary sources of financing include all forms of current
or short-term financing not categorized as spontaneous,
such as bank loans, commercial papers, and financing
6. Permanent soirces of financing include all long-term sources
such as debt having a maturity of more than one year, such
as preferred stock, common stock or long-term bonds.
Working Capital Management
Working capital or short-term financial
management refers to the administration
and control of the more liquid resources to
make sure that they are sufficient to cover
day to day business operations including
• Inventory, accounts receivable, marketable
securities, and cash.
• Notes payable, accruals, and accounts
Firms goal is to minimize net working capital
can be achieve through:
1. Having faster collection of cash from
sales or service revenues;
2. Increasing inventory turnovers
3. Slowing down disbursements to suppliers
or securing longer credit terms.
Objectives of Working Capital Management:
1. To generate additional income for the
2. To reduce the amount of investment
needed to support sales and production
Ratio Change Effect on Profit Effect on Risk
Increase Decrease Decrease
Decrease Increase Increase
Increase Increase Increase
Decrease Decrease Decrease
Cash Conversion Cycle and
A firm’s operating cycle (OC) is the time from
the beginning of the production process
collection of cash from the sale of the finished
product. It is measured in elapsed time by
summing the average selling period (ASP) and
the average collection period (ACP). A firm can
lower its working capital if it can speed up its
OC = ASP + ACP
The cash conversion cycle (CCC) is the
length of time required for a company to
convert cash invested in its operations to
cash received as a result of its operations.
The time it takes to pay the accounts
payable, measured in days, is the average
payment period (APP).
CCC = OC – APP, or
CCC = ASP + ACP - APP
Dorina Company has a n average production
process time of 50 days. Finished goods are kept on
hand for an average of 20 days before they are sold.
Accounts receivable are outstanding an average of
35 days, and the firm receives 50 credit on its
purchases from suppliers.
1. Estimate the average length of the firm’s short-
term operating cycle. How often would the cycle
turn over in a 365 day year?
2. Assume net sales of P1M and cost of goods sold
of P800,000. determine the average investment
in accounts receivable, inventories, and accounts
payable. What would be the net financing need
considering only these three accounts?
Cash Conversion Cycle – Funding
Requirement and Strategies
a permanent funding requirement is a
constant investment in operating assets
resulting from constant sales over time. A
seasonal funding requirement is an investment
in operating assets that varies over time as a
result of cyclic sales. If a firm does not face a
seasonal cycle, then it will face only a
permanent funding requirement. With seasonal
needs the firm must also decide as to how it
wishes to meet the short-term nature of its
seasonal cash demands. The firm may choose
either an aggressive or a conservative policy
towards this cyclical need.
An aggressive funding strategy is a funding
strategy under which the firm funds its seasonal
requirements with short-term debt and its
permanent requirements with long-term debt.
This approach seeks to increase profit by using
as much of the less expensive short-term
financing as possible but increases risk
because the firm operates with minimum net
working capital, which could become negative.
Another factor contributing to risk is the
potential need to quickly arrange for ling-term
funding, which is generally more difficult to
negotiate, to cover shortfalls in seasonal needs.
A conservative funding strategy is a funding
strategy under which the firm funds both its
seasonal and its permanent requirements with
long-term debt. This strategy results in
relatively lower profits because the firm uses
more of the expensive long-term financing and
may pay interest on unneeded funds. The
conservative approach has less risk because of
the high level of net working capita that is
maintained; the firm has reserved short-term
borrowing power for meeting unexpected fund
demands. Under conservative strategy, the
borrowing is often in excess of the actual need.
Dorina Company has a permanent funding
requirement of P135,000 in operating assets
and seasonal funding requirements that vary
between P0 and P990,000 and average
If Dorina can borrow short-term funds at
6.25% and long-term funds at 8%, and if it
can earn 5% on the investment of any
surplus balances, then the annual cost of an
aggressive strategy for seasonal funding will
Cost of short-term financing = (0.0625 x P101,250) P6,328.13
Cost of long-term financing = (0.0800 x 135,00) 10,800.00
Earnings on surplus balances = (0.0500 x 0) 0
Total cost of aggressive strategy= P17,128.13
Alternatively, Dorina can choose a conservative strategy, under which
surplus cash balances are fully invested.
Cost of short-term financing = 0.0625 x P0 = 0
+ Cost of long-term financing = 0.0800 x P1,125,00 = 90,000
- Earnings on surplus balance = 0.0500 x 888,750 = 44,437.50
Total cost of conservative strategy = P45,562.50
Management of Cash
Cash management refers to the most
effective way of handling cash or its
equivalent, in a manner intended to result in
its most efficient use.
Possible placements of cash
1. Savings and/or current accounts
2. Time deposits
4. Treasury bills
5. Commercial papers
Management Techniques in
Controlling Cash Flows
• Float management
this involves controlling the collection
and disbursement of cash. The objective in
cash collection is to reduce the large
between the time customers pay their bills
and the time the checks are collected.
• Speed-up collection
• Concentration Banking
this is a collection procedure in which
payments are made to regionally dispersed
collection centers and then deposited in local banks
for quick clearing thus reducing collection float by
shortening mail and clearing float.
it refers to a collection procedure in which
payers sends their payments to a nearby post office
box that is emptied by the firm’s bank several times
daily. The bank deposits the payment check in the
firms account and reduces collection float by
shortening processing float as well as mail and
• Direct Sends
this is a collection procedure in which
the payee presents payment checks directly
to the banks in which they are drawn, thus
reducing clearing float.
• Slowing Down Disbursements
involves stretching payables by paying
as late as possible within a credit period.
Issuance of checks to suppliers.
• Collecting center or agent
• Estimating Cash Balances
management’s goals are to maintain
levels of transactional cash balances and
marketable securities investment that improve
the value of the firm.
Baumol Model suggests to treats cash as
inventory item, this model determines the
optimum balance of cash based upon carrying
and transaction costs of cash. The carrying
cost refers to the cost of the holding cash, i.e.
interest; and transaction cost refers to the cost
involved in getting the marketable securities
converted into cash.
ECQ = √2 x conversion cost x demand for cash
opportunity cost (in decimal form)
ECQ = economic conversion quantity (the cost-minimizing quantity in
which to convert marketable securities to cash)
Conversion cost = includes the fixed cost of placing and receiving an
order for cash in the ECQ
Demand for cash = cash outlays for upcoming year.
Opportunity cost = the interest earning per dollar given during specified
time period as a result of holding funds in a non-interest cash account
rather than having them invested in interest-earning marketable
Total Cost = (Cost per Conversion x No. of Conversions)
+ (Opportunity cost x Avg. Cash Bal.)
Dorina Inc. takes in P2 million from sales every year. Of this amount
P1.25 million is needed for cash payments for the direct and other
materials used in the manufacture of their products. Each tme the
company transfer funds into its cash account, it incurs a charge of
approximately P30.00, which covers brokerage expenses. Compute the
optimal cash balance or the ECQ if marketable securities yueld is 7%
Conversion cost = P30
Demand for cash = P1,250,000
Opportunity cost = 7%
ECQ = √2x1,250,000 x 30
Hinweis der Redaktion
The financial officer’s response was short and simple. There’s a big difference between profits and cash. We’re making profits, yes, but because of the amazing growth we are experiencing, we had to acquire more new assets than we could finance with retained earnings. We have lots of inventory, receivables and fixed assets, but no cash. We really need to change our operating policies or else we will go bankrupt.
The situation is not unusual. This happens all the time. Setting working capital policy involves answering two basic questions.
Kining two questions are vital to the firm’s profitability
Understand the the terms.
SFM – is primarily concerned with the commitments of funds to various activities within the business and with the best possible combination of types of financing.
Involves that those assets needed by the firm not to be financed by spontaneous sources, such as payables and accruals, should be financed.
Permanent asset investments are financed with permanent sources abd temporary asset investments are financed with temporary sources of financing. Attempts to match.
- generally, deals with managerial decisions regarding current assets and how they are financed.
Cash – should be enough to support firm’s operations
AR – should not be to lax nor too strict in granting credits
Inventories – should be enough to support market demands
Current liabilities – to pre prudent in making use of the time before it finally pays off its obligations
Borrowings are called working capital loans, and they had to be repaid on time to prove to the loan institution that the management’s credit is good so that they could borrow again.
Working capital as defined earlier, is the difference between current assets and total current liabilities.
The ability of the firm to meet current obligations as they come due using current ratio analysis.
However, the use of current ratio must be made with care and caution.
Closer and deeper analysis on components of current assets is very important.
Accounts receivable, pila ka adlaw mareceive
Inventory, pila ka adlaw mahalin
Profitability is the relationship between revenues and costs generated by using the firm’s assets both current and fixed, in productive activities. A firm can increase its profits by increasing revenues and/or decreasing costs. Risk (Insolvency) is the probability that a firm will be unable to pay its bills as they come due. Firm that is insolvet is unable to apy its bills as they come due.
a. OC = ASP + ACP
= 50 + 35 + 20
= 105 days
Cycle turnover = 365/105 days
= 3.48 times
b. Investment in inventory = (800k/365) x (50+20)
Investment in AR = (1M/365) x 35
Accounts Payable = (800k/365) x 50
Net Financing = P139,725.66
Cash is the most important and challenging resources to manage
Influenced by subjective factor
Effective management of the CCC can both reduce the demand for cash and increase its supply.
Make payments that arise in the ordinary course of doing business
Buffer stock of liquid assets to be drawn when there are unexpected demands for cash
Take advantage of future income producing activities
HOWEVER interest earned in this kind of placement is lower
Taxed at 20%. Earned higher interest
Bought from stockbrokers. Entails cost of broker’s commission, government taxes, and DST
Usual 91 days. Government. However there are more than 91 days but not more than 1 yr.
Issued by firms with high credit standings. Interest is normally higher than from savings account.