Working Capital and Policy Management

WORKING CAPITAL AND POLICY MANAGEMENT
4.1 WORKING CAPITAL AND POLICY MANAGEMENT Working capital management focuses on the components that will determine the liquidity of the companys current assets and current liabilities. Operating current assets and current liability whole is known as working capital management. The working capital management has centered on two main areas, namely to determine the appropriate investment capital to current assets and to identify financial resources to fund the expanded current assets.
4.1.1
CONCEPT OF WORKING CAPITAL Working capital is a financial metric which represent operating liquidity available to a business, organization or other entity, including government entity. It is the amount of money that a company has tied up in funding its day to day operations. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operation. Companies with negative working capital may lack the funds necessary for growth. It also called current assets or current capital. In short, it is the management of liquidity ratios.
Working capital = Current Asset
Net working capital (NWC) is the excess of current assets over current liabilities. Net working capital is calculated as current assets minus current liability or the portion of current assets that is financed by long-term funds. It is a derivation of working capital. That is commonly used in valuation technique such as DCFs
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(Discounted cash flows). If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. Current asset are potential sources of cash inflows while current liability are potential sources of cash outflows. These assets must be management efficiently in order to maintain the firms liquidity, while not keeping too high of any one of them. This is because current asset has to be financed. Net working capital = Current Asset Current Liabilities @ Net working capital = Stock + Trade debtor Trade creditor
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 operating 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. Components of working capital comprises current asset and current liability. Current assets include assets owned company that is expected to be converted into cash within a period not exceeding one year. Current liability are short term obligation are companies that need to be resolved on a period not exceeding one year. Among the components involved in the working capital is: a. Cash Cash refers to money in the physical form of currency, such as banknote and coins. In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately. Cash is seen either as a reserve for payments, in case of a structural or incidental negative cash flow or as a
way to avoid a downturn on financial markets. Cash is important for a company because it is the main source to driving force company activities.
b. Current deposit A deposit account is a current account, savings account, or other type of bank account, at a banking institution that allows money to be deposited and withdrawn by the account holder. Some banks charge a fee for this service, while others may pay the customer interest on the funds deposited.
c. Inventory Inventory is the unsold goods or in a waiting delivery to customers and still in the company stock. The raw materials, work-in-process good and completely finished goods that are considered to be the portion of a business's assets that are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company's shareholders/owners.
d. Marketable securities Marketable security is the use of short-term investment of cash surpluses that exist while for a brief period. Very liquid securities that can be converted into cash quickly at a reasonable price. Marketable securities are very liquid as they tend to have maturities of less than one year. Furthermore, the rate at which these securities can be bought or sold has little effect on their prices.
e. Accounts receivable Money which is owed to a company by a customer for products and service provided on credit. This is treated as a current asset on a balance sheet. A specific sale is generally only treated as an account receivable
after the customer is sent an invoice.
f. Prepaid expenses Prepaid expenses A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received in the near future. While prepaid expenses are initially recorded as assets, their value is expensed over time as the benefit is received onto the income statement, because unlike conventional expenses, the business will receive something of value in the near future.
g. Accounts payable An accounting entry that represents an entity's obligation to pay off a short-term debt to its creditors. The accounts payable entry is found on a balance sheet under the heading current liabilities. Accounts payable are often referred to as "payables". Another common usage of AP refers to a business department or division that is responsible for making payments owed by the company to suppliers and other creditors.
h. Accrual account Accrual accounting is considered to be the standard accounting practice for most companies, with the exception of very small operations. This method provides a more accurate picture of the company's current condition, but its relative complexity makes it more expensive to implement. This is the opposite of cash accounting, which recognizes transactions only when there is an exchange of cash.
i. Short-term debt An account shown in the current liabilities portion of a company's balance sheet. This account is comprised of any debt incurred by a company that is due within one year. The debt in this account is usually made up of shortterm bank loans taken out by a company.
4.1.2
WORKING CAPITAL MANAGEMENT Working capital is the money used to make goods and attract sales. The less working capital used to attract sales, the higher is likely to be the return on investment. Working capital management is the administration of the firms currents assets and currents liabilities. It is about the commercial and financial aspects of inventory, credit, purchasing, marketing, and royalty and investment policy. Working capital management involves the relationship between a firm's short-term assets and its short-term liabilities. Working capital management will be focused the decision relating to working capital and short-term financing. The current assets and current liability should be dealt with properly and effectively to ensure the continuity of the company life. So, the goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability 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. Manager should be sensitive to the environment that may affect the daily business of the company that all actions relating to working capital to make the wise there. Effective working capital management is importance for several reasons. First, many financial managers spend a large amount of the time managing current assets and current liabilities. With current asset and current liabilities comprising about 40 percent and 26 percent of the total assets of RM manufacturing firms, respectively, skillful management of these short-term accounts is critical for ensuring that the firm can meet its short-term maturing obligation and provide an attractive return to its shareholder. Second, working capital assets and liabilities are the most manageable account and thus require frequent attention and oversight. Third, current liabilities serve as the major source of external financing for small companies. Managers need to understand how to develop effective working capital policies to ensure growth, profitability, and long-term success for their firms. Firms
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experiencing rapid growth may easily fall into a growth trap with insufficient levels of current assets to support increasingly higher, levels of sales. In such cases, a firm may go broke while making a profit. Small but rapidly growing firms must pay particular attention to maintaining sufficient liquidity through their working capital policies and management.
4.1.3
EFFECT OVER RISK AND RETURN In making a working capital management, the matters to be considered is concerned with the risks to be faced when making the investment and then look at the returns will be accepted. The system is efficient and strategic management is vital in order to balance the liquidity of the assets and liabilities of the company. If there is no proper management of the company's working capital for thecompany he cederung incompetent in administering ormanaging the company and will suffer losses. The effect of working capital for the company's risks and returns are based on the liquidity of an asset to the company. The company has many assets against current assets are not liquid. Low liquidity in the cause of the risk. This is because the lack of ability to convert assets to cash to cash when the situation was desperate. For companies that have more assets when compared to fixed assets, its high liquidity levels and therefore low risk.
Liquidation
= Return @
= Risk
Liquidation
= Return
= Risk
4.1.4
STANDARD WORKING CAPITAL LAVEL Net working capital management involved finance decision simultaneously and it related between investment on current assets and financing of the current liability. One of the method commonly use in working capital management is the principle of shelter financing to match assets with terms of its life. There are three difference approach in shelter principle as follow:
a.
Hedging approach Hedging approach using a permanent source of funding and financing to finance all investment spontaneously to the permanent assets. Investment on the assets while also being funded with temporary funding. The term hedging can be said to a process of maturities of debt with the maturities of financial needs. According to this approach, the maturity of the sources of funds should match the nature of the assets to be financed. For the purpose of analysis, the assets can be broadly classified into two classes: i. Those assets which are required in a certain amount for a given level for operation and hence do not vary over time ii. Those assets which fluctuate over time RM
Short-term Temporary current assets financing
Permanent current assets
Long-term financing
Fixed assets Time
b. Aggressive approach This approach uses more of short-term funds to finance even the permanent current assets. Aggressive approach to using temporary financing in excess of assets while. This mean some resources are also being used on finance parts of the assets remain. This approach is said to be aggressive because of the financial managers face a higher risk and therefore need to actively monitor the movement of the working capital to company liquidity is at a safe level. RM
Temporary current assets
Short-term financing
Permanent current assets Long-term financing Fixed assets Time
c. Conservative approach This approach for managing working capital, the firm uses long-term funds to finance its long term assets, all permanent current assets, and some temporary current assets. Short-term are funds are usually less expensive than long-term funds because the yield curve is typically upward sloping. Thus, when the firm use more long-term interest rates, it can look in its cost of funds and avoid increase in short-term rates. In additional by looking in long-term sources of financing, the firm protects itself against the risk or credit shutoff either general economic conditions or the companys financial condition worsens.
RM Marketable security Temporary current assets Short-term financing Long-term Permanent current assets financing
Fixed asset Time The following chart gives a summary of the relative costs and benefits of the three different approaches: Hedging Approach Moderate Moderate Moderate Conservative Approach More Less Less Aggressive Approach Less More More
Factors Liquidity Profitability Risk
The risk preferences of the management shall decide the approach to be adopted. The risk-neutral will adopt the hedging approach, the risk averse the conservative approach and the risk seekers will adopt the aggressive approach.
4.2 CASH MANAGEMENT AND MARKETABLE SECURITIES In this section we examine financial policies and decisions for managing a firms cash and marketable securities. Cash is the currency and coin the firm keeps on hand in cash registers, petty cash drawers, or in checking accounts at the commercial bank. Marketable securities are short-term investment in securities that the firm can quickly convert into cash. Because of their strong liquidity, marketable securities are often referred to as near cash or near-cash assets. Cash and near-cash assets comprise the liquid assets of a firms.
4.2.1
OBJECTIVE AND FUNCTION CASH MANAGEMENT Cash management is a sophisticated and important aspect of working capital management. The objective in cash management is to keep the investment in cash as low as possible while maintaining the firms efficient operations. To accomplish this objective, managers must determine the target cash balance required to maintain liquidity while minimizing the total costs related to the investment in cash. Cash management involves three major decision areas: 1. Determining appropriate cash balance 2. Investing idle cash 3. Managing collections and disbursement If the level of cash or marketable securities of the companies is too high, profitability is reduced. At the same time, companies should not be saving to little cash and marketable securities in order to avoid possible losses. Therefore, the primary function of cash management is: 1. Companies are required to have cash that enough in order to meet need conduct business. 2. Company should not too keep lot of cash on the other hand but would to make investments for increase the company asset (cash) and cash balance that were minimal.
4.2.2
TRANSACTION FOR CASH COLLECTION AND CASH PAYABLE
Cash Collection There are various methods of collecting cash and logistic regression. Among these methods are: a. Normal methods Normal or common system is one method used to clear the check. Here is the procedure: i. ii. iii. iv. v. Customers to write checks and enter into the letter box. A letter or check send to company headquarters. Checks are processed and incorporate into the companys bank. Funds or money will included in the companys bank account Check send to the clearing house (clearing system) to be reviewed and discussed. vi. The bank will send a notice to the companys state the cheques was explained and money or fund can be used.
b. Lock box system Lock box system is a service that is often used to speed up cash collection. This service is offered by commercial banks. Objectives are to reduce both types of mail float is float and processing float. The program collecting is very simple. Companies will rent a mailbox at the post office and to authorize a bank (where the company has an account) to take the post- delivery letter from the mail box. The following is the procedure of collecting cash from lock box system: i. The customer is directed to make submissions to the cheque box numbered (not to the head office/branch of the company) ii. Bank to take the letter from the mailbox and deposit cheque directly to the account of the company.
iii. Bank can inform the company in respect of the amount deposited into your bank account every day. The company will receive a copy of the deposit and the list of payment along with any letter accompanying the payment. The company receive the cheque form all over the country will have a few locker.
c. Preauthorized cheques system (PAC) The PAC system, the amount of the payment and the date of payment has been set in advance. When the date arrived, payment amount will automatically be deducted from the customers bank account into the account of the company. This system is difference from the normal system of the cheque which they do not contain or require the signature of owner account. This system exists when individuals are given power. This system is used when a company receives payment from customers a lot of the same. Cash collection procedures through the PAC system is: i. Gives customers the power to the companies to write cheque on behalf of their respective account. ii. Guarantee agreement signed by the client and forwarded to the respective bank. This agreement authorizes the bank to pay the PAC is presented for payment. iii. iv. Company provide details on payment information. Bank will receive information from the company, issued a PAC, depositing cheque into company account and advance cheque to be explained by the commercial banking system.
Cash Payable Management There are various methods user for cash payment. The method used are as follow: b. Zero account balance This method of allowing control of the central (headquarters) of all cash payment, but at the same time, power is still there with the company at
branch level. This method can provide better control of the assets of cash payment. The following is a cash payment procedures through zero-balance account:
i. ii.
Employees are authorized to write cheque Cheque through the banking system and will be forwarded to the central bank for the payment issued.
iii.
Cheque payable by bank and negative balance will be reflected in the account.
iv.
The central bank, the same amount will be deducted from your deposit account which is the center main.
c. Payable through draft A draft that is payable through a specific bank. Payable-through-draft instruments draw money from the account of the issuer. Corporations use these instruments to pay bills, and insurance companies use them to pay claims. The bank's name is printed on the face of the draft. However, it does not verify either the signature or the endorsement; this is the responsibility of the issuer. Credit union share drafts are also payable-through-draft instruments, usually cleared by a correspondent bank. Payments through the draft is a normal check. But it is not defined by the bank. Draft was written and charges authorized to be made by the company of its accounts. Bank is a collection center, and he submitted the draft to the company for review and approval of payment. Any draft that did not want to be changed by the company's payment will be refunded to the bank the following day. All the drafts that were returned to the bank to be paid. The main objective of this system is to provide effective control of costs as directed by the headquarter instructed to withhold payment of any draft it deems inappropriate. Charged for each conducted after the draft is reviewed and approved by the company.
4.2.3
THE MARKETABLE SECURITY TYPE AND INVESTMENT IN MARKETABLE SECURITIES
The Marketable Securities Type Marketable securities are investments that are not at risk and can be changed by the company to cash in the short term. There are several types of marketable securities such as treasury bills, bankers' acceptances, negotiable certificates of deposit, repurchase agreements and commercial paper. a. Treasury bills It is the government debt issued to finance the government's annual operating expenses. (published by the federal government, the Central Bank). Treasury bills has maturity period of 3 months, 6 months or 12 month (91 days, 182 days and 364 days). However there are laws that limit the amount of treasury bills issued by the treasury bills cannot be issued in discriminately. Method to purchase of treasury bills is on discounting and the promised face value/par value up on maturity period (in other words the bill is discounted). Treasury bills are a major stake in the bank, while a small number are held by households, businesses and other financial institution. Investors are interested and keen to buy treasury bills because the return very low risk (government guarantee), this bill is liquid (then it most actively traded), a very short period of maturity and bills can be traded, easily transferable. Example: The nominal value of RM100, 000.00 be purchased for RM95, 000.00. Investors will be able to return to RM5, 000. Their discount rate is RM5, 000 from the investment of RM95, 000 or 5.26%
b. Trade bills It is usually a promissory note issued in a short period of 3months to 6 month, issued by some banks and large companies. Commercial paper is a tool to facilitate loans to producers who raise funds quickly. This trade bill is similar
to treasury bills for face value and will purchase based on the principle of discounting. Bills will be redeemed on the date specified, the date of payment of proceeds in respect of business transactions. This bill discounting rates depend on several factors which include higher interest rates in the market, the higher the discount rate and the good name of the issuer in respect of bills, if the small firm/ less known, the higher the discount given to people buying the bill.
c. Banker acceptant Bankers Acceptances are rising as a result of efforts to enhance the quality of a trade bill, the trade bill is sent to a financial institution to be certified and acknowledged acceptance. Contracting parties to the quality of trade bills issued by the firm and who make the bill negotiable and readily accepted by investors. However, bankers acceptances discounted rate is lower than the bill trade without the consent of bankers. Unearned discount rate is lower than the face that they must pay if they earn the same amount of funds through bank loans. Bankers Acceptances are created to facilitate the international trade business. Payment is made at any future date, such as who is listed, and payment is guaranteed by the bank when it has been confirmed receipt. This bill is needed because foreign exporters if the company that buy bankrupt, the bill is still getting paid as guaranteed by the bank. Received by a bank draft is often resold on the secondary market at a discount and function similar to treasury bills.
d. Negotiable Bank Certificate of Deposit (NCD) NCD is a certificate of deposit with a minimum face value of $100,000. These are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed-in before maturity. When one opens a certificate of deposit, the bank issues a certificate that guarantees the holder to be paid back her deposit plus interest. Similar to normal certificates of deposits, negotiable certificate of deposits last for a predetermined duration,
and funds can't be withdrawn from the deposit account until the predetermined date. Typically, negotiable certificate of deposits operate on a short time horizon and mature (funds may be withdrawn) after a year or less. Some negotiable certificate of deposits may have longer terms, and offer higher interest rates. While negotiable certificate of deposits may not be cashed in before the date of maturity, there is an active secondary market for negotiable certificate of deposits where the certificates can be sold.
e. Repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date. The repurchase price will be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan while the settlement date of the forward contract is the maturity date of the loan.
Investment in Marketable Securities Before making an investment in the securities markets, companies must first selected the portfolio of marketable securities, which will bring good returns to the company. The companies should consider the following before making investment: i. Financing risk It involves the inaccuracy of the estimated rate of return on invested securities. Normally, the manager does not require the financial risks can be high market securities when selecting certain assets included in their investment portfolio. ii. Interest risk It involves the uncertainty of the estimated rate of return due to changes in interest rates due to environmental imbalances. iii. Liquidation Companies need to know whether the securities are intended to meet the needs of companies that are at a certain level of liquidity when the company needs it. iv. Tax Companies need to know types of marketable securities of taxable. v. Return Returns estimated by the company the company to generate revenue when firms make investments in securities. This involves the measurement of return on risk and benefits to be gained after the company invests in those securities.
4.2.4
WAY TO IMPROVE THE EFFECIENCY IN CASH MANAGEMENT AND TO MATCH THE COST AND BENEFIT IN FINANCIAL MANAGEMENT The difference between ledger balance and available balance is called a floating. Float is the total number of shares publicly owned and available for trading. The float is calculated by subtracting restricted shares from outstanding shares. A float can also refer to a small portion of the money supply representing a balance that is simultaneously present in a buyers and a payers account. A float results from the delay occurring between the time that a cheque is written and the money actually being deducted from the writer's account. These balances are temporarily double counted as part of the overall money supply. For example, a company may have 10 million outstanding shares, but only seven million are trading on the stock market. Therefore, this company's float would be seven million. Stocks with smaller floats tend to be more volatile than those with larger floats.
Way to Improve the Efficiency in Cash Management Efficiency in cash management can be improved by accelerating the collecting through the lockers. In accelerating the process proceeds through the lockers, there is some float involved. Delaying the payment involves an increase in any one component of a managed float. There are 4 types of float: a. Mail float Time between the first customers to send checks until the check to reach recipients.
b. Processing float The time taken by the recipient of the first he received a cheque, cheque processing until the check is deposited in the bank.
c. Transit float The time taken between the first cheque deposited by the receiver for the bank clearing process so that there are funds that can be used by the company. This float is because the necessary checks through the bank before the check can be explained.
d. Disbursement float Refers to the customer funds in its bank account until the check fees through the banking system.
Written cheque and post
Cheque accepted
Deposited cheque
Cheque described
Mail Float (3 day)
Processing Float (1 day)
Transit Float (5 day)
Disbursement Float (Payment)
Match the Cost and Benefit Financing Management Effective cash management is focused on matching between the costs and benefit benefits involved in a cash management. There are several steps to match the cost and benefit. Formula for calculation is as follows: Step 1: Total collection (sales of a year) = Sale of a year x Total branch Step 2: Daily collection (sales per day) = Total collection / Total day in a year Step 3: Net saving per year = Daily collection x Reducing the floating total x Rate return Step 4: The annual cost of operating lock box system = Lock box rental x Total branch x Month Step 5: Annual net saving cost = Net saving per year - Net saving per year

Working Capital and Policy Management

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Working Capital and Policy Management

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WORKING CAPITAL AND POLICY MANAGEMENT

Working capital = Current Asset

after the customer is sent an invoice.

Short-term Temporary current assets financing

Permanent current assets

Fixed assets Time

Temporary current assets

Permanent current assets Long-term financing Fixed assets Time

Factors Liquidity Profitability Risk

TRANSACTION FOR CASH COLLECTION AND CASH PAYABLE

THE MARKETABLE SECURITY TYPE AND INVESTMENT IN MARKETABLE SECURITIES

Written cheque and post

Mail Float (3 day)

Processing Float (1 day)

Transit Float (5 day)

Disbursement Float (Payment)

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