BLEX™ Program

Financial
Management

Prepared By:
Mr.Aiman Ahmed Ibrahim
Managing Current Asset
What is Working Capital

 Working capital (abbreviated WC) is a

financial metric which represents operating
liquidity available to a business, organization,
or other entity, including governmental
entity. Along with fixed assets such as plant
and equipment, working capital is considered
a part of operating capital.
 Working Capital

 Working Capital = Current Assets

 Net Working Capital = Current Assets − Current

Liabilities

 Equity Working Capital = Current Assets −

Current Liabilities − Long-term Debt
What is Net Working Capital

Net working capital is calculated as :

.
current assets minus current liabilities.
If current assets are less than current liabilities,
an entity has a working capital deficiency,
also called a working capital deficit
What Does Current Assets
Mean?
 A balance sheet account that represents
the value of all assets that are reasonably
expected to be converted into cash within
one year in the normal course of business.
 In personal finance, current assets are all
assets that a person can readily convert to
cash to pay outstanding debts and cover
liabilities without having to sell fixed assets
What Does Current Assets
Mean?

 Cash & Cash Equivalents

 Short-Term Investments
 Inventory
 Accounts Receivable
 Prepaid Expenses
Profitability v.Liquidty

A company can be endowed with assets and

profitability but short of liquidity if its assets
cannot readily be converted into cash. Positive
working capital is required to ensure that a firm
is able to continue its operations and that it has
sufficient funds to satisfy both maturing short-
term debt and upcoming operational expenses.
The management of working capital involves
managing inventories, accounts receivable and
payable and cash
An increase in working capital indicates that
the business has either increased current
assets (that is has increased its receivables, or
other current assets) or has decreased current
liabilities, for example has paid off some
short-term creditors.
Cash Operating Cycle
Working capital management

Decisions relating to working capital and short

term financing are referred to as working capital
management. These involve managing the
relationship between a firm's short-term assets
and its short-term liabilities. The goal of working
capital management is to ensure that the firm is
able to continue its operations and that it has
sufficient cash flow to satisfy both maturing
short-term debt and upcoming operational
expenses.
Management of working
capital
 Working capital also gives investors an idea of
the company's underlying operational efficiency.
Money that is tied up in inventory or money that
customers still owe to the company cannot be
used to pay off any of the company's obligations.
So, if a company is not operating in the most
efficient manner (slow collection), it will show up
as an increase in the working capital. This can be
seen by comparing the working capital from one
period to another; slow collection may signal an
underlying problem in the company's operations.
 Current Asset Management

 Working Capital Management

 Current Asset Investment Policy
 Temporary and Permanent
Current Assets
 Zero Working Capital
 Cash Management
 Marketable Securities
 Accounts Receivable Management
 Inventory Management
 Working Capital Management:

 Gross Working Capital -(Current Assets)

 Net Working Capital - (Current Assets - Current
Liabilities)
 Working Capital Management
 Involves investing in current assets and financing of
current assets:
C u rre n t A s s e t
In v e s tm e n t

C u rre n t L o n g -T e rm
L ia b ilit ie s F in a n c in g
 Current Asset Investment Policy
 Everything else remaining the same, higher levels of
current assets mean lower risk and lower expected
return
 Lower Risk
 Greater ability to meet short-run obligations.
 Lower Return
 Cash and marketable securities typically yield low
returns. Furthermore, when current assets are
increased, additional financing costs will be incurred
thereby lowering returns.
 Lower levels of current assets result in opposite
effects.
Alternative Current Asset Investment
Policies
Current Asset (millions of $)
14 Conservative - low risk
12
10 Moderate

8
Aggressive - high risk
6
4
2
0
0 10 20 30 40
Sales (millions of dollars)
 Temporary vs. Permanent Investment
in Current Assets
 Temporary Investment - Commonly, firms experience
short-run fluctuations in current assets. For example,
retail department stores will have high levels of inventory
around Thanksgiving. In January, the inventory should be
low.
 Permanent Investment - Firms always have some
minimum level of investment in current assets (i.e., a
permanent investment). As a firm grows over time, the
level of permanent current assets also grows (e.g., a
supermarket chain with 70 stores will have more
permanent inventory than a chain with 4 stores).
Temporary and Permanent Current
Assets
Millions of dollars

14 Temporary Fluctuations in
12 Current Assets

10
8
6
4 Permanent Current Assets
2
0
12

15

18

21
0

Time Period
Cash Management:
 Beginning Cash Balance
+ Cash Inflows - - - Speed Up
- Cash Outflows - - - Slow Down
= Ending Cash Balance
- Desired Cash Balance
= Surplus or Shortage
 If Surplus: Pay off short-term debt or buy marketable
securities
 If Shortage: Short-term borrowing or sell marketable
securities
Desired Cash Balance:
 Precautionary Demand - Satisfy possible, but as
yet indefinite cash needs.
 Speculative Demand - Build up current cash
balances in anticipation of future business costs
being lower.
 Risk Preferences
 Compensating Balances
 Transactions Demand - Cash needs arising in the
ordinary course of doing business.
Marketable Securities
 The marketable securities portfolio is typically used for
temporary investments of excess cash, or as a substitute
for cash (i.e., near cash). Therefore, securities in the
portfolio are generally safe, short-term, and highly liquid.
 Treasury Bills
 Short-term obligations of the federal government with
maturities of 91 days to a year. They are traded on a
discount basis in bearer form. Not taxable at state and
local levels, but taxable at the federal level.
 Commercial Paper
 Unsecured promissory notes issued by large
corporations in amounts of $25,000 or more (No active
secondary market).
Marketable Securities Continued
 Negotiable Certificates of Deposit (CDs)
 Offered by financial institutions (e.g., banks, S&Ls).
Those big business is interested in have $100,000
minimums.
 Banker’s Acceptance: Generally arise out of foreign
trade.
 Importer (buyer) issues a promise to pay a certain
amount to the exporter (seller).
 A bank accepts the promise, and commits itself to pay
the amount when due.
 Exporter (seller) can now sell this acceptance in the
marketplace at a discount (a price that is less than the
promised amount).
Accounts Receivable Management

 Major Decisions
 Credit Standards
 Credit Terms
 Collection Policy
 Credit Standards: Will they pay as agreed?
 Credit Scoring
 Credit Reports
 Past Experience
 Financial Analysis
 Debt Ratios, Liquidity Ratios, Profit Ratios
Accounts Receivable Management
(Continued)
 Credit Terms
 Example: 2/10, net 30
 Collection Policy
 Standard Operating Procedures
 Be professional, firm, and do not bluff.
 Vary procedures with slow payers.
 Evaluating Collection Efforts
 Average Collection Period, Bad Debt to Sales Ratio,
Aging Accounts Receivable, Receivables to Assets
Ratio, Credit Sales to Receivables Ratio.
Inventory Management

 Basic Costs Associated With Inventory

 Carrying Costs
 storage, insurance, cost of capital used
 Ordering Costs
 placing orders, shipping and handling
 Costs of Running Short
 lost sales, reduced customer goodwill
 Objective
 Minimize total costs associated with managing
inventory.
Decision criteria

working capital management entails short

term decisions - generally, relating to the
next one year period - which are "reversible".
Positive working capital means that the
company is able to pay off its short-term
liabilities. Negative working capital means
that a company currently is unable to meet its
short-term liabilities with its current assets
(cash, accounts receivable and inventory).
Cash Conversion Cycle
 One measure of cash flow is provided by the cash
conversion cycle - the net number of days from
the outlay of cash for raw material to receiving
payment from the customer. As a management
tool, this metric makes explicit the inter-
relatedness of decisions relating to inventories,
accounts receivable and payable, and cash.
Because this number effectively corresponds to
the time that the firm's cash is tied up in
operations and unavailable for other activities,
management generally aims at a low net count.
Cash Conversion Cycle

CCC = # days between disbursing cash and collecting

cash in connection with undertaking a discrete unit of
operations.
=
Inventory conversion + Receivables - Payables conversion period
period conversion
period

Avg. Inventory COGS / + Avg. Accounts - Avg. Accounts Payable

365 Receivable COGS / 365
Credit Sales /
365
More businesses fail for lack of cash
than for want of profit.

If you ....... Then ......

 Collect receivables (debtors)  You release cash from the
faster cycle
 Collect receivables (debtors)  Your receivables soak up
slower cash
 Get better credit (in terms of
 You increase your cash
duration or amount) from
resources
suppliers
 Shift inventory (stocks) faster  You free up cash
 Move inventory (stocks)  You consume more cash
slower
 Example:
From XYZ's Financial Statements
Information 1-Jan 31-Jan
Balance Sheet    
Accounts Receivables $400 $600
Raw & Finished Goods $500 $300
Inventory
Accounts Payable ($300) ($100)
     
Profit/Loss Statement    
Sales   $1,000
Cost of Goods Sold   ($700)
Gross Margins   $300
     
 Solution:
XYZ's Cash-to-Cash Cycle for the Period January 1 Through January 31
Component   Computation   Result
Inventory - Average =($500 + $300 / 2) / ($700 / 31 days) = 17.7
number of days
Receivables - Average =($400 + $600 / 2) / ($1,000 / 31 days) = 15.5
number of days
uncollected
Days Cash Is Free =(-$300 + -100 / 2) / ($700 / 31 days) = -8.8
Because the Business
Has Not Paid Its Bills
    Cash-to-Cash Cycle (in days)   24.4
    
   
FACTORS INFLUENCING WORKING CAPITAL
NEEDS:

 Nature of Business.
 Seasonality of Operations:
  Production Cycle.
 Production Policy.
  Credit Policy.
 Market Conditions.
  Conditions of Supply.
CONCLUSION:

The objective of financial management is to

maximize the shareholders wealth by generate
sufficient profits. The profits generated depend
mainly on sales volume. When the goods are
being sold on credit as is the normal practice of
business firms today to cope with increased
competition the sale of goods cannot be
converted into cash instantly because of time lag
between sales and realization of cash. Further
this is possible only through evolving effective
working capital policy and better administration
on current assets financing.