Working Capital Management 2018

WORKING CAPITAL MANAGEMENT involves the administration, within policy guideline, of current assets and current liabilities.
- Important Elements:
o Inventory management
o Cash management
o Credit and collection policy
o Short-term borrowings.
- Primarily concerned with day-to-day operations.
- The primary objective is to achieve a balance between return (profitability) and risk.

WORKING CAPITAL POLICY involves decision relating to current assets, including decisions the financial manger must take about the financing
of current assets.
- Firm’s basic policies regarding: 1) Target levels for each category of current assets, and
2) How current assets will be financed as reflected in the firm’s target current and quick ratios.
- Involves two basic questions:
1. Wat is te appropriate level of current assets, both in total and by specific accounts?
2. How should the required level of current assets be financed?
- ALTERNATIVE CURRENT ASSET INVESTMENT POLICIES
a. LOOSE WORKING CAPITAL POLICY – relatively large amounts of cash, marketable securities and inventories are carried, and that
sales are stimulated by the use of credit policy which provides liberal financing to customers and hence high level of receivables.
b. TIGHT WORKING CAPITAL POLICY – the holdings of cash, securities, inventories and receivables are minimized.
c. MODERATE WORKING CAPITAL POLICY – between the two extremes.
o Under CONDITIONS of CERTAINTY – when sales, costs, order lead times, collection periods, and so on are known with
certainty – all firms would hold the same level of current assets.
 Any larger amount would increase the need for external funding without a corresponding increase in profits.
 While smaller amount would cause late payment to suppliers, lost sales, and production inefficiencies because of
inventory shortages.
o Under CONDITIONS of UNCERTAINTY the firms requires some minimum amount of cash and inventories based on expected
payments, sales, order lead times, and so on, plus additional amounts, or safety stocks, to help it cope if things vary from their
expected values.
 Accounts receivables are still based on credit terms, and the tougher those terms, the lower the receivables for any
given level of sales.
 With tight working capital policy, the firm would hold minimal levels of safety stocks for cash and inventories, and it
would have a tight credit policy even though this mean running the risk of losing some sales.
o GENERALLY, a tight working capital policy provides the highest expected return on investment, but it also entails the greater
risk, while the reverse is true under a loose policy.
- ALTERNATIVE FINANCING POLICY
a. MODERATE (MATURITY MATCHING/ SELF-LIQUIDATING OR HEDGING POLICY)
 One commonly used financing policy, matching asset and liability maturities.
 Matching the maturity of a financing source with specific financing needs.
 Short-term assets are financed with short-term liabilities.
 Long-term assets are funded by long-term financing sources.
 Both fixed assets and permanent current assets are financed with long-term capital-equity plus long term debt.
 This strategy reduces the risk that the firm will be unable to pay off its maturing obligations.
b. AGGRESSIVE (RESTRICTED) POLICY
 One which finances all of its fixed assets with long-term capital but part of its permanent current assets with short-term
credit.
 Operations are conducted on a minimum amount of working capital
 Uses short-term liabilities to finance, not only temporary, but also part or all of the permanent current asset requirement.
 This would be a very risky, non-conservative position, and the firm would be highly exposed to loan renewal problems and
to the danger of having its interest expense skyrocket if interest rates rise.
 ADVANTAGES: increases return on equity (profitability) by taking advantage of the cost differential between long-term
and short-term.
 DISAVANTAGES: 1. Exposure to risk arising from low working capital position.
2 Puts too much pressure on the firm’s short term borrowing capacity so that it may have difficulty in
satisfying unexpected needs for funds.
c. CONSERVATIVE (RELAXED) POLICY
 Permanent capital is being used to finance all permanent assets requirements and also to meet some or all of the seasonal
demands.
 Operations are conducted with too much working capital
 Involves financing almost all asset investments with long-term capital.
 Represent very safe, conservative working capital financing policy.
 ADVANTAGES: Reduces risk of illiquidity & Eliminates the firm’s exposure to fluctuating loan rates and potential
unavailability of short-term credit.
 DISADVANTAGE: Less profitable because of higher financing costs.
d. BALANCE POLICY
 Balances the trade-off between risk and profitability in a manner consistent with its attitude toward bearing risk.

PERMANENT CURRENT ASSETS – even business is at its seasonal or cyclical low, its current assets do not drop to zero.
o Current assets that are still on hand at the trough of a firm’s cycle.
o The portion of the company’s current assets required to maintain the firm’s daily operations.
o It is the minimum level of current assets required if the firm is to continue its operations.
 TEMPORARY CURRENT ASSETS – current assets that fluctuate with seasonal or cyclical variations in firm’s business.
o Current assets, such as cash, that fluctuate with the firm’s operational needs.
- DECIDING ON AN APPROPRIATE WORKING CAPITAL POLICY
a. ASSET MIX DECISION – appropriate mix of current and non-current assets.
b. FINANCING MIX DECISION – appropriate mix of short-term and long-term liabilities to finance current assets.
- Determination of a firm’s investment in net operating working capital and how that investment is financed are elements of working capital
policy.
WORKING CAPITAL (gross working capital) – simple refers to current assets.
- A firm’s investment in short-term assets – cash, marketable securities, inventory, and accounts receivable.

NET WORKING CAPITAL is current assets less current liabilities

 Working Capital Management 2018

CASH CONVERSION CYCLE was developed by Verlyn Richards and Eugene Laughlin as a useful approach to analyzing the working capital cash
cycle. The length of time it takes for the initial cash outflows for goods and services to be realized as cash inflows from sales.
- INVENTORY CONVERSION PERIOD is the average length of time required to convert raw materials into finished goods and then to sell
these goods.
o Inventory Conversion Period = 360/ / inventory turnover ratio.
o Inventory Turnover = COGS / Average Inventory
- RECEIVABLES CONVERSION PERIOD is the average length of time required to convert the firm’s receivables into cash, that is, to
collect cash following a sale.
o Also called as “average collection period”
o Receivable Conversion Period = 360 / Account receivable turnover ratio
o A/R Turnover = Net Credit Sales / Average A/R
- PAYABLES DEFERRAL PERIOD the average length of time between the purchase of raw materials and labor, and the payment of cash
for them.
o Payables Deferral Period = 360 / A/P Turnover Ratio
o A/P Turnover = Net Credit Purchases / Average A/P
- CASH CONVERSION CYCLE which nets out of the 3 periods. Equals the length of time between the firm’s actual cash expenditures on
productive resources and its own cash receipts from the sale of products.
o It measures the length of time of the firm has funds tied up in working capital.
o ICP + RCP – PDR = CCC.
o The firm’s goal should be to shorten its cash conversion cycle as much as possible without hurting operations. This would
improve profits, because the longer the cash conversion cycle, the greated the need for external financing - and such financing
has a cost.
o CCC can be shortened:
1. By reducing the inventory conversion period (processing and selling goods more quickly.)
2. By reducing the receivable conversion period (speeding up collections) or
3. By lengthening the payables deferral period (slowing down its own payment)

RISK RETURN TRADE-OFF

 The greater the risk, the greater is the potential for larger returns.
 More current assets lead to greater liquidity but yield lower returns (profit).
 Fixed assets earn greater returns than current assets.
 Long-term financing has less liquidity risk than short-term debt, but has a higher explicit cost, hence, lower return

ADVANTAGES AND DISADVANTAGES OF SHORT-TERM CREDIT

1. SPEED
 A short-term loan can be obtain much more quickly than a long-term loan.
 If funds are needed in a hurry, the firm should looks to the short-term markets.
2. FLEXIBILITY
 If its needs for funds are seasonal or cyclical, a firm may not want to commit itself to long-term debt for the following reasons:
o FLOTATION COSTS are generally much higher for long-term debt.
o While long-term debt can be repaid clearly provided the loan agreement includes a prepayment provision, prepayment
penalties can be expensive.
o Long-term loan agreements always contain provisions, or covenants, which constrains the firm’s future actions; short-
term credit agreements are generally less restrictive.
3. COST OF LONG-TERM VS. SHORT-TERM DEBT
 Interest rates are generally lower on short-term than on long-term debt.
 Interest expense at the time the funds are obtained will be lower if the firm borrows on a sort-term rather than a long term basis.
4. RISK TO THE BORROWER
 Financing with short-term debt subjects the borrowing firm to greater risk than does financing with long-term debt.
 This added risk occurs for two reasons:
i. If a frim borrows on a long-term basis, its interest costs will be fixed and therefore stable over time, but if short-term
credit, its interest expense will fluctuate widely, at time going quite high.
ii. If a firm borrows heavily on a short-term basis, it may find itself unable to repay this debt, and it may be in such a weak
financial position that the lender will not extend the loan; this could force into bankruptcy.

ADDITIONAL INFORMATIONS:
 Merchandise sold at a profit, but the sales is on credit will cause an increase in working capital
 Accruals are free in the sense that no explicit interest is paid on these funds.
 A conservative approach to working capital will result in all permanent assets being financed using long-term securities.
 The risk to the firm of borrowing with short-term credit is usually greater than with long-term debt. Added risk can stem from greater
variability of interest costs on short-term debt.
 A company may hold a relatively large amount of cash if it anticipates uncertain sales levels in the coming year.
 Credit policy has an impact on working capital since it has the potential to influence sales level and the speed with which cash is collected.
 The cash budget is useful in determining future financing needs.
 Managing working capital levels is important to the financial staff since it influences financing decisions and overall profitability of the
firm.
 Although short-term interest rates have historically averaged less than long-term rates, the heavy used of short-term debt is considered to be
an aggressive strategy because of the inherent risks of using short-term financing.
 If the firms receive trade credit under the terms 2/10, net 30 days, this implies the company has 10 days of free trades.

CASH AND MARKETABLE SECURITIES MANAGEMENT

CASH MANAGEMENT
- CASH (currency plus demand deposits) is needed to pay for labor and raw materials, to buy fixed assets, to pay taxes, and so on.
- Neither currency nor most commercial checking accounts earns interest, so cash is generally called a “NON-EARNING” asset.
- The goal of the cash managers is to reduce the amount of cash held to the bare minimum necessary to conduct business.
- Involves the maintenance of the appropriate level of cash and investment in marketable securities to meet the first’s cash requirements and
to maximize on idle funds,
- OBJECTIVE: to invest excess cash for a return while retaining sufficient liquidity to satisfy needs.
- A firm’s peak borrowing needs will probably be overstated if it bases its monthly cash budget on uniform cash receipts and disbursements,
but actual receipt are concentrated at the beginning of each month.
 Working Capital Management 2018

- Short-term cash budgets, in general, are used for actual cash control while long-term budgets are used primarily for planning purposes.
-

REASONS FOR HOLDING CASH

1. TRANSACTION PURPOSES – the firm’s maintain cash balances that
 Cash balances are needed to meet cash outflow requirements for operational or financial obligations.
 Transactions Balances are cash balances associated with routine payments and/or collections.
2. COMPENSATING BALANCE REQUIREMENT – a certain amount of cash that a firm must leave in its checking account at all times as
part of a loan agreement.
 These balances give banks an additional compensation because they can be relent or used to satisfy reserve requirements.
 When a bank is providing services to a customer, it generally requires the customer to leave a minimum balance of deposit to
help offset the costs of doing so. Also known as a COMPENSATING BALANCE.
3. PRECAUTIONARY RESERVES – firms hold cash balance in order to handle unexpected problems or contingencies due to the uncertain
pattern of cash inflows and outflows.
 Firms need to hold some cash in reserve for random, unforeseen fluctuations in inflows and outflows.
 PRECAUTIONARY BALANCES are safety stocks – the less predictable the firm’s cash flows, the larger such balanced should
be.
4. SPECULATION – firms delay purchases and store up cash for use later to take advantage of possible changes in prices of materials,
equipment, and securities, as well as changes in currency exchange rates.
 SPECULATIVE BALANCES are some cash balances held to enable the firm to take advantage of any bargain purchases that
might arise.
5. POTENTAIL INVESTMENT OPPPORTUNITIES – excess cash reserves are allowed to build up in anticipation of a future investment
opportunity such as a major capital expenditure project.

ADVANTAGES OF HOLDING ADEQUATE CASH BALANCES

1. To take trade discounts.
2. Adequate holdings of cash and near cash assets can help the firm maintain its credit rating by keeping the current and acid test ratios in line
with those of other firms in its industry.
 Strong credit rating enables the firm to purchase goods from suppliers on favorable terms as well as to maintain a line of credit
with its bank.
3. Useful for taking advantage of favorable business opportunities.
4. To meet such emergencies as strikes, fires, or competitors’ marketing campaigns.

CASH FLOW SYNCHRONIZATION

- A situation in which inflows coincide with outflows, thereby permitting a firm to hold transactions balances to a minimum.

USING FLOAT
- FLOAT is defined as the difference between the balance shown in a firm’s checkbook and the balance on the bank’s record.
o The amount of funds tied up in checks that have been written but are still in process and have not yet cleared.
o Example: Suppose a firm writes checks in the amount of $5,000 each day, and it takes about six days fir these checks to clear and
to be deducted from the firm’s bank account. Thus, the firm’s own checkbook shows a balance of $30,000 smaller than the
bank’s records; this amount is called DISBURSEMENT FLOAT. If the firm received checks in the amount of $5,000 daily but
losses four days while they are being deposited and cleared, it will have $20,000 in COLLECTION FLOAT.
o For a firm that makes heavy use of float, being able to forecast its collections and disbursements check clearing is eesential.
- A firm’s NET FLOAT is a function of its ability to speed up collections on checks received and to slow down collections on checks
written.
- Efficient firms go to great lengths to speed up the processing of incoming checks, thus putting the funds to work faster, and they try to
stretch their own payments out as long as pos
- TWO ASPECTS OF FLOAT
i. The time it takes a company to process its checks internally.
ii. The time consumed in clearing the check through the banking system.
- TYPES OF FLOAT
i. NEGATIVE FLOAT – book balance exceeds the bank balance which means that there is more cash tied up in the collection
cycle and it earns 0% rate of return. (These floats must be minimized, if not eliminated.)
 MAIL FLOAT – customer payments that have been mailed by the customer but not yet received by the seller.
 PROCESSING FLOAT – customer payments that have been received by the seller but not yet deposited.
 CLEARING (TRANSIT) FLOAT – customers’ checks that have been deposited but not yet cleared.
ii. POSITIVE FLOAT (DISBURSEMENT FLOAT) – the firm’s bank balance exceeds its book balance. (Management should
increase this type of float.)

CASH MANAGEMENT STRATEGIES

1. ACCELERATE CASH COLLECTIONS – reduce negative float.
a) Bill customer promptly
b) Offer cash discounts for prompt payment
c) Use of lockbox system – customer mail their payments to a post office box in a specific city. The local bank collects the
checks from this box and deposits them in the firm’s account.
 This reduced mail float
 Lockbox plan does have a cost. The local banks will charge the firm for the collection and funds transfer services
rendered.
 To determine whether a lockbox system is advantageous, the firm must compare the bank fees with the gains from
reducing float.
d) Establish local collection office
e) Request customers to make direct payment to the firm’s depository bank.
f) Use of automatic fund transfer or Electronic Fund Transfer (EFT).
2. CONTROL (SLOW DOWN) DISBURSEMENTS.
a) Stretch payables by paying as late as possible within the credit period.
b) Maintain “ZERO-BALANCE ACCOUNT” – checks are written from special disbursement accounts having zero peso
balance (no minimum maintaining cash balance required), Funds are automatically transferred from a master account when
a check drawn from a ZBA is presented.
c) Play the float – increase the positive float.
d) Less frequent payroll and schedule issuance of checks to suppliers.
 Working Capital Management 2018

Used of Drafts – a draft must be transmitted to the issuer, who approves it and deposits funds to cover it, and only then can it
e)
be collected.
3. REDUCE THE NEED FOR PRECAUTIONARY CASH BALANCE
a) More accurate cash budgeting
b) Have ready lines of credit
c) Invest idle cash in highly liquid, short-term investments instead of holding idle precautionary cash balances.

TRANSFER MECHANISMS
- Is a system for moving funds among accounts at different banks.
- MAIN TRANSFER MECHANISM
a. DEPOSITORY TRANSFER CHECK
 It looks like an ordinary check, except that it is restricted for deposit into a particular account at a particular bank.
 Payable only to the bank of deposit for credit to the firm’s specific account.
 It provide a means of moving funds from local depository banks to regional concentration banks and then into the firm’s
primary money center bank.
 CONCENTRATION BANK are larger bank to which the firm channels funds from the local depository banks which
operate its lockboxes.
b. ELECTRONIC DEPOSITORY TRANSFER CHECKS (EDTC)
 An alternative transfer mechanism is the electronic image transfer via automated clearinghouse run by the Federal Reserve
System.
 It is a combination of a wire and a DTC.
 Paperless but in involves uniform, one-day availability in clearing time because it avoids the used of the mails.
c. WIRE TRANSFERS
 Makes funds collected at one bank immediately available for use at another bank, even in a different city.
 It is the fastest wat to move cash between banks, and it completely eliminates transit float.
 Quickest transfer mechanism, but it is also the most expensive.

CASH FLOW MANAGEMENT

1. Preparing cash budgets
2. Preparing the cash break-even chart
 It shows the cash break-even point – the amount of sales in pesos or the number of units to be sold so tat the total cash inflows is
equal to the cash outflows.
 It shows the amount of cash deficiency when sales is below the cash break-even point, or the amount of excess cash when sales is
above the cash break-even point.
3. Determining the optimal cash balance using the Baumol Cash Management Model
 An EOQ type model which can be used to determine the optimal cash balance where the costs of maintaining and obtaining cash
are at the minimum.
 It assumes:
o That the firm uses cash at a steady, predictable rate
o That the firm’s cash inflows from operations also occur at a steady
o That the firms’ net cash outflows, or net need for cash, also occur at a steady rate.
 Obviously simplistic in many respects. Most important, it assumes relatively stable, predictable cash inflows and outflows and it
does not take account of any seasonal or cyclical trends.
 Such costs are the:
I. Cost of securities transactions or cost of obtaining a loan;
II. Opportunity cost of holding cash which includes the return foregone by not investing in marketable securities or the
cost of borrowing cash.
2𝑇𝐷
OPTIMAL CASH BALANCE: OC = √
𝑖
T = transaction cost which is a fixed amount per transactions. It includes the cost of securities
transactions or cost of obtaining a loan.
i = interest rate on marketable securities or the cost of borrowing cash
D = total demand for cash over a period
𝐷
No. of Transaction per year =
𝑂𝐶

ADDITIONAL INFORMATIONS:
 By reducing the company’s DSO it can sharply reduce its cash conversion cycle.
 Payments lag, payment for plant construction, and cumulative cash are typically part of the cash budget.
 Cash budget: depreciation expense it not explicitly included, but depreciation effects are implicitly included in estimated tax payments.
 Cash proceeds from selling one of its divisions and interest paid on its bank loans should explicitly be included in company’s monthly cash
budget.
 A cash management system which minimizes collections float and maximized disbursement float is better than one with higher collections
float and lower disbursement floats.
 A firm which has such an efficient cash management systems that it has positive net float can have a negative checkbook balance at most
times and still not have its checks bounce.
 Ignoring cost and other effects on the firm, forgo discounts that are currently being taken would tend to reduce cash conversion cycle.
 Actions that are likely to reduce the length of a company’s cash conversion cycle:
o Adopting a new inventory system that reduces the inventory conversion period.
o Reducing the average days sales outstanding on its accounts receivables.
 For some firms holding highly liquid marketable securities is a substitute for holding cash, because the marketable securities accomplish
the same objective as cash.
 The typical actual cash budget will reflect interest on loans and income from investment of surplus cash. These numbers are expected
values and actual results might vary from budgeted results.
 Lockbox plan is most beneficial to firms which make collections over a wide geographic area
 Poor synchronization of cash flows which results in high cash management costs can be partially offset by increasing disbursement float
and decreasing collections float.

MANAGEMENT OF MARKETABLE SECURITIES

- MARKETABLE SECURITIES is a short-term money market instruments that can easily be converted to cash.
 Working Capital Management 2018

o Examples: Government Securities and Commercial Papers (unsecured promissory notes issued by corporations with very high
credits standing.)

REASONS FOR HOLDING MARKETABLE SECURITIES

1. MS serve as substitute for cash (transactions, precautionary and speculative) balances.
 Some firms hold portfolio or MS in lieu of larger cash balances, then sell off some securities to increase the cash account when
cash outflows exceed inflows.
 In most cases the securities are held primarily for precautionary purposes – most firms prefer to rely on bank credit to make
temporary transactions or to meet speculative needs, but they still want some liquid assets to guard against a possible shortage of
bank credit if problems should arise.
2. MS serve as a temporary investment that yields return while funds are idle.
 Temporary investments in MS generally occur in one of the 3 following situations:
a) When the firm must finance seasonal or cyclical operations.
b) When the firm must meet some known financial requirements.
c) When the firm has just sold long-term securities.
3. Cash is invested in MS to meet known financial obligations (e.g. tax payment & loan amortizations)

DECISION CRITERIA FOR MARKETABLE SECURITIES

I. RISK
a) DEFAULT RISK – refers to the chances that the issuer may not be able to pay the interest or principal on time or not at all.
b) INTEREST RATE RISK – refers to fluctuations in securities’ price caused by changes in market interest rates.
 As rates change, the value of a debt security changes in the opposite direction.
c) INFLATION RISK / PURCHASING POWER RISK – refers to the risk that inflation will reduce the “real value” on the
investment.
 Important both to firms and to individual investors during the times of inflation, is generally regarded as being lower on
assets whose returns normally rise during inflation than on assets whose returns are fixed.
II. MARKETABILITY – refers to how quickly a security can be sold before maturity without a significant price concession.
 An asset that can be sold on short notice for close to its quoted market price.
III. TERM OF MATURITY – maturity dates of marketable securities held should coincide, when possible, with the date at which the firm
needs cash, or when the firm will no longer have cash to invest.

When company has conservative working capital financing policy, then its long-term capital will exceed its permanent assets and it will hold MS
when inventories and receivables are LOW.
 Least risky, but it also has the lowest expected rate of return.

With an aggressive policy, it will never carry any securities, and it will borrow heavily to meet peak needs.
 Most risky – the firm’s current ratio is always lower than under the other plans because the firm has fewer assets and more short-
term debt, indicating that it might encounter difficulties either in borrowing the funds needed or in repaying the loan.
 On the other hand, it requires no holdings of low-yielding MS, and this will probably lead to a relatively high expected rate of
return on both assets and equity.

With a moderate policy, under which maturities are matched, the firm will finance permanent assets with long-term capital, and it will finance some
of its seasonal increase in inventories and receivables with short-term loans, but it may also carry and then sell off marketable securities.

ADDITIONAL INFORMATION:
 The following are situations that might lead a firm to hold marketable securities:
o The firm must meet a known financial commitment, such as financing an ongoing construction project.
o The firm must finance seasonal operations
o The firm has just sold long-term securities and has not yet invested the proceeds in earning assets.


MANAGEMENT OF ACCOUNTS RECEIVABLE

- Formulation and administration of plans and policies related to sales on account and ensuring the maintenance of receivables at a
predetermined level and their collectability as planned.
- OBJECTIVE: to have both the optimal amount of receivables outstanding and the optimal amount of bad debts.
o This balance requires the trade-off between:
a. The benefit of more credit sales, and
b. The costs of accounts receivable such as collection, interest, and bad debts cost.
- The average accounts receivables balance is determined jointly by the volume of credit sales and the days sales outstanding.
- If a firm has a large percentage of accounts over 30 days old, it is NOT a sign that the firm’s receivables management needs to be reviewed
and improved.
- The aging schedule is a commonly used method of monitoring receivables.
- Offering trade

FACTORS IN DETERMINING ACCOUNTS RECEIVABLE POLICY

1. CREDIT STANDARDS – the criteria that determine which customers will be granted credit and how much.’
 The credit standard should not be too stringent or too tights which may eliminate the risk of non-payment, but also eliminate
potential sales to rejected customers;
o Neither should the standards be too loose, which may lead to higher sales, but also higher bad debt losses and collection
costs.
 Factors to consider in establishing credit standards – the Five C’s of Credit
o Character – a customer’s willingness to pay
o Capacity – a customer’s ability to generate cash flows
o Capital – a customer’s financial sources such as collateral
o Collateral – represented by assets that customers may offers as security in order to obtain credit.
o Conditions – current economic or business conditions
2. CREDIT TERMS – define the credit period and any discount offered for early payment.
 Costs and Benefits of a credit extension policy
o Cash discounts
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o Credit and collection costs

o Bad debt losses
o Financing costs

CREDIT POLICY
- Four Elements of Credit Policy
1. Credit Period – length of time buyers have before they must pay for their purchases.
2. Credit Standards – refers to the minimum financial strength of acceptable credit customers.
 Refer to the strength and creditworthiness a customer must exhibit in order to qualify for credit.
 Setting credit standards implicitly requires a measurement of credit quality, which is defined in terms of the probability of a
customer’s default.
3. Collection Policy – reflects the firm’s toughness or laxity in following up on slow-paying accounts.
 Procedure the firm follows to collect receivables.
4. Discounts given for early payment

OTHER FACTORS INFLUENCING CREDIT POLICY

1. Profit Potential
2. Legal Considerations in Granting Credit
3. Credit Instruments
 Most credit is offered on open account, which means that the only formal evidence of the credit is an invoice which
accompanies the shipment and which the buyer signs to indicate that goods have been received.
 Promissory Note a document specifying the amount, percentage interest rate, repayment schedule, and other terms and
conditions of a loan.
o Useful (1) if the order is very large; (2) if the seller anticipates the possibility of having trouble collecting; and
(3)if the buyer wants a longer than usual time period in which to pay for the order.
 Commercial Draft is a post-dated draft drawn up by and made out to the seller that must be signed by the buyer before
taking possession of goods.
o The seller draws up a draft, which looks like a check made out to the seller and payable by the buyer but at some
future date.
o Sight Draft is a draft that is payable upon acceptance by the buyer.
 Upon the delivery of the shipping document and acceptance of the draft by the byer, the bank will
actually withdraw money from the buyer’s account and forward it to the selling firm.
o Time Draft (Trade Acceptance) is a draft that is payable on a specified future date.
o Banker’s Acceptance is a time draft that has been guaranteed by a bank.
 This is widely used, especially in foreign trade.
 Have a low degree of risk if guaranteed by a strong bank.
o Conditional Sales Contract is a method of financing in which the seller retains titles to the goods until the buyer
has completed payment.
 Primarily used for sales of such items as machinery, dental equipment, and te like, which are often paid
for an installment basis over a period of two or three years.
 Advantage: relatively easy for the seller to repossess the equipment in the event of default.

WAYS OF ACCELERATING COLLECTION OF RECEIVABLES

1. Shorten credit terms
2. Offer special discounts to customers wo pay tier accounts within a specified period.
3. Speed up the mailing time of payments from customers to the firm.
4. Minimize float, that is, reduce the time during which payments received by the firm remain uncollected funds.

DETERMINANTS OF THE SIZE OF RECEIVABLES

1. Terms of sale
2. Paying practices of customers
3. Collection policies and practices
4. Volume of credit sales
5. Credit extension policies and practices
6. Cost of capital

AIDS IN ANALYZING RECEIVABLES

1. Ratio of receivables to net credit sales
2. Receivable turnover
3. Average collection period
4. Aging of accounts

ADDITIONAL INFORMATIONS:
 Analyzing day sales outstanding (DSO) and the aging schedule are two common methods for monitoring receivables. However, they can
provide erroneous signals to credit managers when sales fluctuate seasonally.
 Easing a firm’s credit policy lengthens the collection period and results in a worsening of the aging schedules, however, firms take such
action because it normally stimulates sales and to meet competitive pressures.
 If the yield curve is upward sloping, then a firm’s marketable securities portfolio, assumed to be held for liquidity purposes, should be
weighted toward short-term securities to avoid interest rate risk.
 If the required compensating balance is larger than the transaction balance the firm would ordinarily hold, then the effective cost of any
loan requiring such a balance is increased.
 In managing a firm’s account receivable it is possible to increase credit sales per day yet still keep account receivable fairly steady if the
firm can shorten the length of its collection period.
 The DSO of a firm with seasonal sales can vary. While the sales per day figure is usually based on the total annual sales, the accounts
receivable balance will be high or low depending on the season.
 If a firm sells on terms of 2/10, net 30 days, and its DSO is 30 days, then its aging schedule would probably show some past due accounts.

MANAGEMENT OF INVENTORIES
- Formulation and administration of plans and policies to efficiently and satisfactorily meet production and merchandising requirements and
minimize costs relative to inventories.
 Working Capital Management 2018

- OBJECTIVE: to maintain inventory at a level that best balances the estimates of actual savings, the cost of carrying additional inventory,
and the efficiency of inventory control.
- The principal goal of most inventory management systems is to balance the costs of ordering, shipping and receiving goods with the cost of
carrying those goods, while simultaneously meeting the firm’s policy with respect to avoiding running short of stock and disrupting
production schedules.
- Inventories may be grouped into 3 classifications:
1) Raw Materials
2) Work-in-process
3) Finished goods
- Inventories must be acquired ahead of sales. The need to forecast sales before establishing target inventory levels makes inventory
management a difficult task.
- Managers must maintain inventories at levels which balance the benefits or reducing the level of investment against the costs associated
with holding smaller inventories.
- Inventory management focuses on 3 basic questions:
1) Ow many units of each inventory item should the firm hold in stock?
2) How many units should be ordered (or produced) at a given time?
3) At what point should inventory be ordered (or produced)?
- DETERMINING THE INVENTORY INVESTMENT
1) A working stock must be on hand to meet expected needs for the items, with the size of the stock depending on expected
production and sales levels.
2) Because demand may be greater than expected, it is necessary to have a safety stock on hand.
-

INVENTORY MANAGEMENT TECHNIQUES

1. INVENTORY PLANNING – determination of the quality and quantity and location of inventory, as well as the time of ordering, in order
to meet future business requirements.
 ECONOMIC ORDER QUANTITY (EOQ) Model – the quantity to be ordered, which minimized the sum of the ordering and
carrying costs.
 The total inventory cost function includes:
a) Carrying Cost – which increase with order size
 Generally rise in direct proportion to the average amount of inventory carried, which in turn
depends on the frequency with which orders are placed.
 Costs associated with carrying inventories, including storage, capital, and depreciation costs.
i. Storage cost
ii. Interest cost
iii. Spoilage
iv. Insurance
b) Ordering Costs – which decrease with order size
 The cost of placing and receiving an order; these costs are fixed for each order regardless of the
sixed of the order.
i. Transportation (delivery costs)
ii. Administrative cost of purchasing and costs of receiving and inspecting goods
2𝑎𝐷
 FORMULA: EOQ = √
𝐾
Where: a = cost of placing one order (ordering cost)
D = Annual demand in units
K = Annual costs of carrying one unit in inventory for one year
 Assumptions:
1) Demand occurs at a constant rate throughout the year.
2) Lead time on the receipts of the orders is constant.
3) The entire quantity ordered is received at one time.
4) The unit costs of the items ordered are constant; thus, there can be no quantity discounts.
5) There are no limitations on the size of the inventory.
2𝑎𝐷
 Manufacturing Operations: ECONOMIC LOT SIZE (ELS) = √
𝐾
Where: a = set up cost
D = Annual production requirement
K = Annual costs of carrying one unit in inventory for one year
 When the EOQ figure is available, the average inventory is computed as follows:
 Reorder Point
𝐸𝑂𝑄
 FORMULA: AVERAGE INVENTORY =
2
 When to reorder is a stock-out problem.
 OBJECTIVE: to order at a point in time so as not to run out of stock before receiving the inventory ordered but not so
early that an excessive quantity of safety stock is maintained.
 When the order point is computed, there may be a stock-out situation if:
1) Demand is greater than expected during the lead time; or
2) The order time exceeds the lead time.
 LEAD TIME – period between the time the order is placed and received.
 NORMAL TIME USAGE – normal lead time x average usage
 SAFETY STOCK = (Maximum lead time – Normal lead time) x Average Usage
 REORDER POINT if there is NO Safety Stock required = normal lead time usage
o = Safety Stock + Normal Lead Time Usage
o = Maximum Lead Time x Average usage
 Just-in-Time (IJT)
2. INVENTORY CONTROL – regulation of inventory within predetermined level; adequate stocks should be available to meet business
requirements, but the investment in inventory should be at minimum.
 FIXED ORDER QUANTITY SYSTEM – an order for a fixed quantity is placed when the inventory level reaches the reorder
point.
 FIXED REORDER CYCLE SYSTEM (Periodic Review or Replacement System) – orders are made after a review of inventory
levels has been done at regular intervals.
 OPTIONAL REPLACEMENT SYSTEM
 Working Capital Management 2018

ABC CLASSIFICATION SYSTEM – inventories are classifies for selective control.

A items – high value items requiring highest possible control
B items – medium cost items requiring normal control
C items – low cost items requiring the simplest possible control
3. MODERN INVENTORY MANAGEMENT – often applied in the context of automated manufacturing.
 MATERIALS REQUIREMENT PLANNING (MRP) – designed to plan and control raw materials used in production.
o The demand for materials, which is assumed to be dependent on some factors, is programmed into a computer.
 MANUFACTURING RESOURCE PLANNING (MRP II) – a closed loop system that integrated all facets of a business,
including inventories, production, sales and cash flows.
 ENTERPRISE RECSOURCE PLANNING (ERP) – integrates the information systems of the whole enterprise.
o All organization operations are connected and the organization itself is connected with its customers and suppliers.

INVENTORY MODELS
- A basic inventory model exists to assist in two inventory questions.
1. How many units should be ordered?
2. When should the units be ordered?

ADDITIONAL INFORMATION:
 The following might be attributed to efficient inventory management:
o High inventory turnover ratio
o Low incidence of production schedule disruptions
o High total assets turnover


SHORT-TERM FINANCING
- SHORT-TERM CREDIT – debt scheduled to be paid within one year.
o Four Major Sources
i. Accrued wages and taxes
 Accruals are continually recurring short-term liabilities.
ii. Trade credit among firms
iii. Loans from commercial banks
iv. Commercial paper
-

Factors Considered in Selecting the Source of Short-term Financing

1. Cost – short-term debt is less expensive.
 Short-term rates are usually lower than long-term rates.
 Short-term debts do not normally involve floatation or placement costs.
2. Availability of the short-term funds when needed
3. Risk – short-term debts are riskier. Interest rates may fluctuate and more frequent debt servicing is required.
4. Flexibility – short-term loans can be arranged more quickly.
 Short-term credit is usually more flexible than long-term debt.
 Some lenders are more willing than others to work with the borrower.
5. Restrictions – certain lenders may impose restrictions, such as requiring a minimum level of net working capital.
6. Effect of Credit Rating – some sourced of short-term credit may negatively affect the company’s credit rating.
7. Expected money-market conditions
8. Inflation
9. The company’s profitability and liquidity positions, as well as the stability of its operations.

SOURCES OF SHORT-TERM CREDIT

1. Spontaneous Sources
A. TRADE CREDIT (Accounts Payable) – considered as a spontaneous financing because it is automatically obtained when a firm
purchases goods or services on credit from a supplier.
 It is a continuous source of financing.
 It is more readily available than other negotiated sources of short-term credit.
 Usually bears no interest, but it is not costless. Its cost is implicit in the term of credit agreed upon.
i. No Trade Discount – purchases on credit without trade discount are usually priced higher than cash purchases. The
difference between selling prices is the implicit cost of credit.
ii. With Trade Discount – an implicit cost is incurred if the discount is not availed of.
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 𝑁𝑜.𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
 Annual Rate = x
100%−𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 % 𝑁𝑒𝑡 𝑃𝑒𝑟𝑖𝑜𝑑−𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑝𝑒𝑟𝑖𝑜𝑑
 Net Period or number of days the account is outstanding.
 Two Components:
i. Free Trade Credit – which involved credit received during the discount period.
ii. Costly Trade Credit – which involves credit in excess of the free credit and whose cost is an implicit one based on
the foregone discounts.

B. ACCRUALS (Accrued Expenses) – represent liabilities for services that have been provided to the company but have not yet been
paid for.
 Cost of Accruals – non, whether implicit or explicit costs
C. DEFERRED INCOME – customer’s advance payments or deposits for goods or services that will be delivered at some future date.
2. Negotiated Sources
A. Unsecured Short-term Credit
1) COMMERCIAL BANK LOANS – short-term business credit provided by commercial banks, requiring the borrower to sign
a promissory note to acknowledge the amount of debt, maturity and interest.
a. Line of Credit – the bank agrees to lend up to a maximum amount of credit to a firm. This is applicable to firms
that need frequent funding in varying amounts.
i. Revolving Credit Agreement – the bank makes a formal, contractual commitment to provide the
maximum amount to a firm. The firm pays a minimal commitment fee per year on the average unused
portion of the commitment.
b. Transaction Loan (a single payment loan) – short term credit for a specific purpose.
 Working Capital Management 2018

i. Cost of Bank Loans

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
1. Regular Interest Rate =
𝐵𝑜𝑟𝑟𝑜𝑤𝑒𝑑 𝐴𝑚𝑜𝑢𝑛𝑡
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
2. Discounted Interest Rate =
𝐵𝑜𝑟𝑟𝑜𝑤𝑒𝑑 𝐴𝑚𝑜𝑢𝑛𝑡−𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
3. Effective Interest Rate =
𝑈𝑠𝑎𝑏𝑙𝑒 𝐿𝑜𝑎𝑛 𝐴𝑚𝑜𝑢𝑛𝑡
 Usable Loan Amount = 𝑙𝑜𝑎𝑛 𝑎𝑚𝑜𝑢𝑛𝑡 − 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑐𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑛𝑔 𝐵𝑎𝑙𝑎𝑛𝑐𝑒
 Compensating Balance - a certain percentage of the face amount of the loan that must be
maintained by a borrower on his account.
o FEATURES OF A COMMERCIAL BANK LOANS
 Maturity – although banks do make longer-term loans, the bulk of their lending is on a short-term basis.
Bank loans to businesses are frequently written as a 90-day notes.
 Promissory Notes – it specifies:
i. The amount borrowed
ii. The percentage interest rate
iii. The repayment schedule
iv. Any collateral that might be put up as security for the loan
v. Any other terms and conditions to which the bank and the borrower have agreed.
 Compensating balance – a minimum checking account balance that a firm must maintain with a
commercial bank, generally equal to 10 to 20 percent of the amount of loans outstanding.
 Line of Credit – is an arrangement in which a financial institution commits itself to lend up to a
specified maximum amount of funds during a designated period.
 It is a formal or informal understanding between the bank and the borrower indicating the
maximum credit the bank will extend to the borrower.
 Revolving Credit Agreement – a formal line of credit extended to a firm by a bank or other lending
institution.
2) COMMERCIAL PAPER – short-term, unsecured promissory notes issued by large firms with great financial strength and
high credit rating to other companies and institutional companies.
o Entail lower cost than bank financing (the interest rate is usually lower that the prime rate and the costly financial
arrangements are avoided.)
o Disadvantage: limited access and availability. Only largest firms with greatest financial strength can issue
commercial papers. The amount of funds available is limited to the excess liquidity of big corporations.
o Prime Interest Rate – the rate charged by commercial banks to their business clients. It is usually the lowest rate
charged by banks.
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐶𝑜𝑠𝑡 /𝑝𝑒𝑟𝑖𝑜𝑑 𝑁𝑜.𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
o Effective Annual Interest Rate = x
𝑈𝑠𝑎𝑏𝑙𝑒 𝐿𝑜𝑎𝑛 𝐴𝑚𝑜𝑢𝑛𝑡 𝑁𝑜.𝑜𝑓 𝑑𝑎𝑦𝑠 𝑓𝑢𝑛𝑑𝑠 𝑎𝑟𝑒 𝑏𝑜𝑟𝑟𝑜𝑤𝑒𝑑
B. Secured Short Term Credit
1) Pledging Receivables – a certain peso amount of receivables is provided by the borrowers as collateral for a short-term loan.
 Characterized by the fact that the lender not only has a claim against the receivables but also has recourse to the
borrower, which means that if the person or firm that bought the goods does not pay, the selling firm must take the loss.
2) Pledging Inventories – part or all of the borrower’s inventories are provided by the borrowers as collateral for a short-term loan.
o Classifications of Inventory Loans
i. FLOATING LIEN – the creditor has a general claim on all of the borrower’s inventory.
 The lender acquires title to the inventory and the borrower cannot control its size or
disposition.
 The borrower is free to sell inventories, and thus the value of the collateral can be reduced
below the level that existed when the loan was granted.
ii. TRUST RECEIPT - the lender holds title to specific units of inventory pledged which are identified in
writing on documents called trust receipts.
 An instrument acknowledging that the borrower holds certain goods in trust for the lender.
 The trust receipt stated that the goods are held in trust for the lender and that any proceeds
from the sale of the goods must be transmitted to the lender at the end of each day.
iii. WAREHOUSE RECEIPT – the inventory pledged is placed under the lender’s physical and legal
possession.
 The pledged inventory is stored in a public warehouse controlled by the warehousing
company.
 The inventory is released to the borrower only when such release is authorized by the lender.
 The lending institution employs the warehousing company to exercise control over the
inventory and to act as the lender’s agent.
3) Other Sources of Short-term Funds
a. Factoring of Accounts Receivables – a factor buys the accounts receivable of a firm and assumes the risk of collection.
 Involves the purchase of accounts receivable by the lender, generally without recourse to the borrower, so if
the purchases of the goods do not pay for them, the lender rather than the seller of the goods takes the loss.
 The buyer of the goods is typically notified of the transfer and is asked to make payment directly to financial
institution.
 Since factoring firms assumes the risk of default on bad accounts, it must make the credit check.
b. Banker’s Acceptances – often used by importers and exporters, these are drafts drawn by a non-financial firm on
deposits at a bank. It is a guarantee of payment at maturity.

ADDITIONAL INFORMATIONS:
 Firms generally choose to finance temporary net operating working capital with short-term debt because matching the maturities of assets
and liabilities reduces risk.
 Commercial Papers
o Is generally written for terms less than 270 days
o Generally carries an interest rate below the prime rate
o Is sold to money market mutual funds, as well as to other financial institutions and non-financial corporations.
o A type of unsecured promissory note issued by large, strong firms.
 Trade credit is provided to a business only when purchases are made.
 Short-term debt, while often cheaper than long-term debt, exposes a firm to the potential problems associated with rolling over loans.
 Under normal conditions, a firm’s expected ROE would probably be higher if it financed with short-term rather than with long-term debt,
but the use of short-term debt would probably increase the firm’s risk.
 Statements about the flexibility, cost and riskness of short-term versus long-term credit are dependent on the type of credit that is actually
used.
 Working Capital Management 2018

FORMULAS
ECONOMIC ORDER QUANTITY (EOQ) – for merchandising
 Oldest and most commonly known inventory control techniques
 Things to consider:
1) The demand should be known and constant
2) Lead time is also known and constant
3) Order arrives in one batch at one point in time
4) No quantity discounts avail
5) Ordering cost and holding cost are the only relevant cost. If order are placed on time there will be no stock-out or shortages.
6) EOQ application is per item.
2𝐷𝑂
 Q* (EOQ optimal) = √ Where: D = Annual Demand; O = Ordering Cost; and H = average holding cost/unit
𝐻
𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 (𝐷)
 No, of Orders made in a year: y* =
Q∗
Q∗ 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 (𝑊𝐷)
 Cycle: C = or Note: If WD is not given; the assumption is that company is working at 365 days a year
𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 (𝑑) y∗

𝐷
 Annual Ordering Cost: AOC* = xO
Q∗

Q∗
 Annual Holding Cost: AHC* = ( ) (𝐻)
2

 Total Inventory Cost = TIC = AOC* + AHC*

 Maximum Inventory Level: IMAX* = Q*

Q∗
 Average Inventory Level: AVT* =
2

𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑
 Daily demand (d): d* =
360𝑑𝑎𝑦𝑠

ECONOMIC PRODUCTION QUANTITY (EPQ)

 Basic Assumptions:
1) Only one item is involved
2) Annual demand is known
3) Usage rate is constant
4) Usage occurs continually but production occurs periodically
5) Production rate is constant
6) Lead time does not vary
7) No quantity discounts
2𝐷𝑆 𝑝
 EPQ = √ 𝑥√ where: p = production or delivery rate ; u = usage rate
𝐻 𝑝−𝑢
 Total Cost = Carrying Cost + Set-up Cost
𝐼𝑀𝐴𝑋
 Carrying cost = 𝑥𝐻
2
𝐸𝑃𝑄
 IMAX = 𝑥 (𝑝 − 𝑢)
𝑝
𝐷
 Set-up cost = 𝑥𝑠
𝐸𝑃𝑄
𝐸𝑃𝑄
 Cycle time is time between orders =
𝑢
𝐸𝑃𝑄
 Run time (production face of the cycle) =
𝑝
𝐼𝑀𝐴𝑋
 Average Inventory =
2

REORDER POINT
 Particular point in the inventory level when order is place.
 A function of demand and lead time
 Company who uses ROP has no surplus and shortages.
 Normal Situation:
ROP = daily demand (d) x lead time (L)
 Things to remember
1) If L is shorter than cycle (C), ROP can be computed easily and simple: ROP = d x L
2) If L is greater than C, we have to make series of adjustments before we can apply for the ROP formula:
A.
3)

FINANCIAL RATIOS FORMULAS

𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠−𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
 Current Ratio = Quick Ratio =
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 360 𝑑𝑎𝑦𝑠
 Receivable Turnover = Average Age of Receivable =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 360 𝑑𝑎𝑦𝑠
 Inventory Turnover = Average Age of Inventory =
𝐴𝑣𝑒.𝑀𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑈𝑠𝑒𝑑 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑀𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒
 Raw Materials Turnover = Work in Process Turnover =
𝐴𝑣𝑒.𝑅𝑎𝑤 𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝐴𝑣𝑒.𝑊𝐼𝑃 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑂𝐺𝑆
 Finished Goods Turnover =
𝐴𝑣𝑒.𝐹𝑖𝑛𝑖𝑠ℎ𝑒𝑑 𝐺𝑜𝑜𝑑𝑠 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
 Operating Cycle = Average Age of Inventory + Average age of Receivables
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 360 𝑑𝑎𝑦𝑠
 Trade Payables Turnover = Average Age of Trade Payables =
𝐴𝑣𝑒.𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠+𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠
 Current Assets Turnover =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
 Working Capital Management 2018