CHAPTER 17

Working
Capital
Management
is
associated with short-term financial
decision making.
Short-term Financial Decisions typically
involve cash inflows and outflows that
occur within a year or less.
Long-term Financial Decisions are
involved when a firm purchases special
equipment that will reduce operating costs
over, say, the next five years.

FACTORS AFFECTING THE

WORKING CAPITAL POLICY
1.
2.
3.
4.

FIRMS

The nature of operations

The volume of sales
The variation of cash flows
The operating cycle period

TRACING CASH AND NET WORKING

CAPITAL
1.

2.

Operating Cycle. The length of

time in which the firm purchases
or produce inventory, sell it and
receive cash.
Cash Conversion Cycle. The
length of time funds is tied up in

working capital or the length of

time between paying for working
capital and collecting cash from
the sale of inventory.
a. Inventory Conversion Period.
The average time required to
purchase raw materials and
convert them into finished
goods and then sell them.
b. Average Collection Period.
The average length of time
required to convert the firms
receivables into cash, that is,
to collect cash following a
sale.
c. Payables Deferral Period.
The average length of time
between the purchase of
materials and labor or
merchandise
and
the
payment of cash for them.
The Operating Cycle (days)
Operating Cycle = Inventory Conversion
Period + Average Collection Period
Operating Cycle = (Inventory x 365)/Cost
of Sales + (Accounts Receivable x
365)/Credit Sales

The Cash Conversion Cycle (days)

Cash Conversion Cycle = Operating Cycle

Average Payment Period

2.

Cash Conversion Cycle = Operating Cycle

(Accounts Payable x 365)/Cost of Sales
CCC = Inventory Conversion Period +
Average Collection Period Payables
Deferral Period
Inventory Conversion Period = Average
inventory/(Cost of sales/365)
Average Collection Period = Average
Accounts Receivable/(credit sales /365)
Payables Deferral Period =
Payables/(Cost of sales/365)

Average

3.

Restricted
Current
Asset
Investment Policy This is a policy
under which holdings of cash,
securities, inventories and receivables
are minimized. Marginal carrying
costs of current assets will decrease
while marginal shortage costs will
increase.
Moderate Current Asset Investment
Policy This is a policy that is
between the relaxed and restricted
policies. This policy dictates that the
firm will have just enough current
assets so that the marginal carrying
costs and marginal shortage costs are
equal, thereby minimizing total cost.

ALTERNATIVE POLICIES AS TO THE

SIZE OF THE INVESTMENT IN
CURRENT ASSETS

COSTS RELEVANT TO INVESTMENT IN

CURRENT ASSETS

1.

Carrying Costs are the cost associated

with having current assets.

Relaxed Current Asset Investment

Policy This is a policy under which
relatively large amounts of cash,
marketable securities and inventories
are carried and under which sales are
stimulated by granting liberal credit
terms resulting in a high level of
receivables. In this policy, marginal
carrying costs of current assets will
increase while marginal shortage
costs will decrease.

Shortage Costs are the costs associated

with not having current assets.

CHAPTER 18