This slide is for Overview of working capital management

1. 1
CChhaapptteerr 88
OOvveerrvviieeww ooff
WWoorrkkiinngg CCaappiittaall
MMaannaaggeemmeenntt

2. 2
OOvveerrvviieeww ooff WWoorrkkiinngg
CCaappiittaall MMaannaaggeemmeenntt
Working Capital Concepts
Working Capital Issues
Financing Current Assets:
Short-Term and Long-Term Mix
Combining Liability Structure
and Current Asset Decisions

3. 3
WWoorrkkiinngg CCaappiittaall CCoonncceeppttss
NNeett WWoorrkkiinngg CCaappiittaall
Current Assets - Current Liabilities.
GGrroossss WWoorrkkiinngg CCaappiittaall
The firm’s investment in current assets.
WWoorrkkiinngg CCaappiittaall MMaannaaggeemmeenntt
The administration of the firm’s current assets and
the financing needed to support current assets.

4. 4
SSiiggnniiffiiccaannccee ooff WWoorrkkiinngg
CCaappiittaall MMaannaaggeemmeenntt
In a typical manufacturing firm, current
assets exceed one-half of total assets.
Excessive levels can result in a substandard
Return on Investment (ROI).
Current liabilities are the principal source of
external financing for small firms.
Requires continuous, day-to-day managerial
supervision.
Working capital management affects the
company’s risk, return, and share price.

5. 5
SSuummmmaarryy ooff tthhee OOppttiimmaall
AAmmoouunntt ooff CCuurrrreenntt AAsssseettss
SSUUMMMMAARRYY OOFF OOPPTTIIMMAALL CCUURRRREENNTT AASSSSEETT AANNAALLYYSSIISS
PPoolliiccyy LLiiqquuiiddiittyy PPrrooffiittaabbiilliittyy RRiisskk
AA HHiigghh LLooww LLooww
BB AAvveerraaggee AAvveerraaggee AAvveerraaggee
CC LLooww HHiigghh HHiigghh
1. Profitability varies inversely with
liquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)

6. 6
CCllaassssiiffiiccaattiioonnss ooff
WWoorrkkiinngg CCaappiittaall
CCoommppoonneennttss
Cash, marketable securities,
receivables, and inventory
TTiimmee
Permanent
Temporary

7. 7
PPeerrmmaanneenntt
WWoorrkkiinngg CCaappiittaall
TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss rreeqquuiirreedd ttoo
mmeeeett aa ffiirrmm’’ss lloonngg--tteerrmm mmiinniimmuumm nneeeeddss..
PPeerrmmaanneenntt ccuurrrreenntt aasssseettss
TIME
DOLLAR AMOUNT

8. 8
TTeemmppoorraarryy
WWoorrkkiinngg CCaappiittaall
TThhee aammoouunntt ooff ccuurrrreenntt aasssseettss tthhaatt vvaarriieess
wwiitthh sseeaassoonnaall rreeqquuiirreemmeennttss..
PPeerrmmaanneenntt ccuurrrreenntt aasssseettss
TIME
DOLLAR AMOUNT
TTeemmppoorraarryy ccuurrrreenntt aasssseettss

9. 9
FFiinnaanncciinngg CCuurrrreenntt AAsssseettss::
SShhoorrtt--TTeerrmm aanndd LLoonngg--TTeerrmm MMiixx
SSppoonnttaanneeoouuss FFiinnaanncciinngg:: Trade credit, and
other payables and accruals, that arise
spontaneously in the firm’s day-to-day
operations.
Based on policies regarding payment for
purchases, labor, taxes, and other expenses.
We are concerned with managing non-spontaneous
financing of assets.

10. 10
HHeeddggiinngg ((oorr MMaattuurriittyy
MMaattcchhiinngg)) AApppprrooaacchh
AA mmeetthhoodd ooff ffiinnaanncciinngg wwhheerree eeaacchh aasssseett wwoouulldd bbee ooffffsseett wwiitthh
aa ffiinnaanncciinngg iinnssttrruummeenntt ooff tthhee ssaammee aapppprrooxxiimmaattee mmaattuurriittyy..
Short-term financing**
TIME
DOLLAR AMOUNT
Long-term financing
CCuurrrreenntt aasssseettss**
FFiixxeedd aasssseettss

11. 11
HHeeddggiinngg ((oorr MMaattuurriittyy
MMaattcchhiinngg)) AApppprrooaacchh
** Less amount financed spontaneously by payables and accruals.
**** In addition to spontaneous financing (payables and accruals).
Short-term financing**
TIME
DOLLAR AMOUNT
Long-term financing
CCuurrrreenntt aasssseettss**
FFiixxeedd aasssseettss

12. 12
FFiinnaanncciinngg NNeeeeddss aanndd
tthhee HHeeddggiinngg AApppprrooaacchh
Fixed assets and the non-seasonal portion
of current assets are financed with long-term
debt and equity (long-term profitability
of assets to cover the long-term financing
costs of the firm).
Seasonal needs are financed with short-term
loans (under normal operations
sufficient cash flow is expected to cover the
short-term financing cost).

13. 13
SSeellff--LLiiqquuiiddaattiinngg NNaattuurree
ooff SShhoorrtt--TTeerrmm LLooaannss
Seasonal orders require the purchase of
inventory beyond current levels.
Increased inventory is used to meet the
increased demand for the final product.
Sales become receivables.
Receivables are collected and become cash.
The resulting cash funds can be used to pay
off the seasonal short-term loan and cover
associated long-term financing costs.

14. 14
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff
((CCoonnsseerrvvaattiivvee AApppprrooaacchh))
FFiirrmm ccaann rreedduuccee rriisskkss aassssoocciiaatteedd wwiitthh sshhoorrtt--tteerrmm bboorrrroowwiinngg
bbyy uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff lloonngg--tteerrmm ffiinnaanncciinngg..
TIME
DOLLAR AMOUNT
Long-term financing
CCuurrrreenntt aasssseettss
FFiixxeedd aasssseettss
SShhoorrtt--tteerrmm ffiinnaanncciinngg

15. 15
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff
((CCoonnsseerrvvaattiivvee AApppprrooaacchh))
LLoonngg--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss
Less worry in refinancing short-term obligations
Less uncertainty regarding future interest costs
LLoonngg--TTeerrmm FFiinnaanncciinngg RRiisskkss
Borrowing more than what is necessary
Borrowing at a higher overall cost (usually)
RReessuulltt
Manager accepts less expected profits in
exchange for taking less risk.

16. 16
RRiisskkss vvss.. CCoossttss TTrraaddee--OOffff
((AAggggrreessssiivvee AApppprrooaacchh))
Firm increases risks associated with short-tteerrmm bboorrrroowwiinngg bbyy
uussiinngg aa llaarrggeerr pprrooppoorrttiioonn ooff sshhoorrtt--tteerrmm ffiinnaanncciinngg..
Short-term financing
TIME
DOLLAR AMOUNT
Long-term financing
CCuurrrreenntt aasssseettss
FFiixxeedd aasssseettss

17. 17
CCoommppaarriissoonn wwiitthh aann
AAggggrreessssiivvee AApppprrooaacchh
SShhoorrtt--TTeerrmm FFiinnaanncciinngg BBeenneeffiittss
Financing long-term needs with a lower interest
cost than short-term debt
Borrowing only what is necessary
SShhoorrtt--TTeerrmm FFiinnaanncciinngg RRiisskkss
Refinancing short-term obligations in the future
Uncertain future interest costs
RReessuulltt
Manager accepts greater expected profits in
exchange for taking greater risk.

18. 18
SSuummmmaarryy ooff SShhoorrtt-- vvss..
LLoonngg--TTeerrmm FFiinnaanncciinngg
Financing
Maturity
Asset
Maturity
SHORT-TERM LONG-TERM
Low
Risk-Profitability
Moderate
Risk-Profitability
Moderate
Risk-Profitability
High
Risk-Profitability
SHORT-TERM
(TTeemmppoorraarryy)
LONG-TERM
(PPeerrmmaanneenntt)

19. 19
CCoommbbiinniinngg LLiiaabbiilliittyy SSttrruuccttuurree
aanndd CCuurrrreenntt AAsssseett DDeecciissiioonnss
The lleevveell ooff ccuurrrreenntt aasssseettss and the
mmeetthhoodd ooff ffiinnaanncciinngg tthhoossee aasssseettss are
iinntteerrddeeppeennddeenntt.
A ccoonnsseerrvvaattiivvee ppoolliiccyy of “high” levels of
current assets allows a more aaggggrreessssiivvee
method of financing current assets.
A ccoonnsseerrvvaattiivvee method of financing
(all-equity) allows an aaggggrreessssiivvee ppoolliiccyy
of “low” levels of current assets.