CHAPTER 3

FINANCIAL PLANNING TOOLS AND CONCEPTS

PLANNING

- Is very much related to another management function, controlling. These two management
functions reinforce each other, and both are very important for the success of an organization.

MANAGEMENT PLANNING

- Is about setting the goals of the organization and identifying ways to achieve them. This may
be broken down into long-term plans and short-term plans.
- Long-term plans are reflected in a company’s business strategy.
- In the process of planning, resources have to be identified. These resources include:
a. Manpower resources – total number of individuals who are employed in a company.
b. Production Capacity – the maximum product output in a company.
c. Financial resources – these are funds and assets that finance the business activities
and investments.

Once the plan is set, it has to be quantified. Quantified plans are in the form of budgets and
projected financial statements. These budgets and projected financial statements are then
compared with the actual performance. This where the controlling function comes into plans.
Controlling goes beyond comparing plans with actual performance.

STEPS IN PLANNING

1. SET GOALS OR OBJECTIVES

- the goals of a company can be divided into short-term, medium-term, and long-term goals.
Short-term goals – can be for 1 year
Medium-term goals – can be between one to 3 years
Long-term goals – can be 5 to 10 years
- Should be SMART (Specific, Measureable, Attainable, Realistic and Time bounded)
- Long-term and medium-term plans are generally established during strategic planning where
the vision and mission of a company are formulated or revisited.
VISION – describes what top managers want their company to become
MISSION – describes how the company will achieve its vision and makes the purpose and
objectives of the company clear.

EXAMPLE: Vision and Mission Statement of Jollibee Food Corp.

VISION:
To be among the top 5 restaurant companies in the world.

MISSION:
To serve a great-tasting food, bringing the joy of eating to
everyone.

- Short-term goals are designed to support medium-term and long-term goals. These short-
term goals are supposed to be planned every year and can be even broken down into
quarterly goals for monitoring purposes.

2. IDENTIFY RESOURCES
 - Resources includes production capacity, human resources who will man the operations and
financial resources.

3. IDENTIFY GOAL-RELATED TASKS

- Management must figure out how to achieve an objective.
EXAMPLE:
If the target for this year is to increase sales by 15%, tasks should be considered to
achieve this goal.

4. ESTABLISHED RESPONSIBILITY CENTERS FOR ACCOUNTABILITY AND TIMELINE:

- if the tasks are already identified to achieve the goals, the next important step to do is to
identify which department should be held accountable for this task.

5. ESTABLISH AN EVALUATION SYSTEM FOR MONITORING AND CONTROLLING:

- The management must establish a mechanism which will allow plans to be monitored. This
can be done through quantified plans such as budgets and projected financial statements.

6. DETERMINE CONTINGENCY PLANS

- In planning, contingencies must be considered as well. Budgets and projected financial
statements are anchored on assumptions. If these assumptions do not become realities,
management must have alternative plans to minimize the adverse effects on the company.

BUDGET PREPARATION

1. Sales budget

- The most important financial statement account in forecasting is sales because almost all
other accounts in the financial statements are affected by sales. If you analyse the statement of
comprehensive income, the accounts such as the cost of goods sold, gross profit, variable operating
expenses are also based on sales. Looking at the accounts in the statement of financial position,
almost all of them are correlated with sales. The amount of cash that the company maintains, its
accounts receivable and inventories, property plant and equipment and trade payables are also
affected by sales.
- Given the importance of the sales forecast, the financial manager must be able to support this
figure with reasonable assumptions. The following external and internal factors should be considered
in forecasting sales.

EXTERNAL INTERNAL

● Gross Domestic ● Production capacity

Product (GDP) growth ● Man power requirements
rate ● Management style of mangers
● Inflation ● Reputation and network of the
● Interest Rate controlling stockholders
● Foreign Exchange ● Financial resources of the
Rate company
● Income Tax Rate
● Developments in the
industry
● Competition]economi
c Crisis
● Regulatory
Environment
● Political Crisis
 External and Internal factors influencing sale, among others:

- Macroeconomic Variables (external)

Macroeconomic variables such as the GDP rate, inflation rate, and interest rates, among
others play an important role in forecasting sales because it tells us how much the consumers
are willing to spend. A low GDP rate coupled by a high inflation rate means that the
consumers are spending less on their purchases of goods and services. This means that we
should not forecast high sales of the periods of low GDP.

- Development in the Industry (External)

Suppose you are selling bread and you know that each person in your community eats an
average of one loaf of bread a day. The population of your community is 500 people. If you
are the only person selling bread in your own, then your sales forecasts is 500 units of bread.
However, you also have to take account your competition. What if there are 4 other sellers
of bread? You will need to have to divide the sales between the 5 of you. Does this mean
your new forecast should be 100 units of bread? You should also know the preference of
your consumers. If more of them would prefer to buy more bread from you, then you should
increase your sales forecast.

- Production Capacity and Manpower (Internal)

Suppose that you have already evaluated the macroeconomic factors and identified that
there is a very strong market for your product and consumers are very likely to buy from you.
You forecasted that you will be able to sell 1,000 units of your product. However, you only
have 20 employees who are able to produce 20 units each. Your capacity cannot cover your
expected demand hence, you are limited by it. To be able to increase capacity, you should be
able to expand your operations.

Example: The required production of BCD Company in the first quarter is 200,000 units.
The units increaased by 10% per quarter. The selling price per unit is Php. 5.00.

BCD Company
Sales Budget
For the Year Ending December 31, 2020

QUARTER

1 2 3 4 Year

Units to be sold 200,000 220,000 240,000 260,000 920,000

Unit selling price 5 5 5 5 5

(Peso)

Sales Revenue (Peso) 1,000,000 1,100,000 1,200,000 1,300,00 4,600,000

0
2.
Production Budget – provides information regarding the number of units that should be
produced over a given accounting period based on expected sales and targeted level of ending
inventories. It is computed as follows:

Required Production in Units = Expected Sales + Target Ending

Inventories – Beginning Inventories

Note: Ending Inventory of the current period is beginning inventory of next period
● Example: Problem: Determine the units to be produced by BCD Company in 2020:

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Projected Units 200,000 220,000 240,000 260,000

Target Level Ending 22,000 24,000 26,000 28,000

Inventories

The beginning inventory is 20,000 units

Solution:
BCD Company
Production Budget (In Units)
For the Year Ending December 31, 2020

QUARTER

1 2 3 4 Year In

Projected Sales 200,000 220,000 240,000 260,000 920,000

Add: Target Level 22,000 24,000 26,000 28,000 28,000

of Ending
Inventories

222,000 244,000 266,000 288,000 948,000

Total

Less: Beginning 20,000 22,000 24,000 26,000 20,000

Inventories

Required 202,000 222,000 242,000 262,000 928,000

Production

order to get the production units, add the target level of ending inventories and then less the beginning
inventories.
Take Note:
- The ending inventory level of the present month/quarter will be the beginning inventory level
of the next month/quarter.
- The target level of ending inventories of the fourth quarter is the same as that for the year.
- The beginning inventory of the first quarter is the same as the beginning inventory for the
year. (Cayanan & Borja)
From a number of units that is expected to be produced, the cost of production can be estimated
especially if the company has developed standard production cost per unit. This information can also
be used then in preparing projected financial statements and cash budgets.
1. Operating Budget
● Iut is made to estimate how much their revenue and expenses would be within a year. It is
composed of the variable and fixed cost needed to run the operations of the business like
wages and salaries of personnel, tax payments, interest payments, and rent payments.
2. Cash Budget
● it is displays the expected cash receipts and disbursements for an accounting period. It is
prepared on a monthly or quarterly basis for a year.
● The cash budget is divided into three parts: cash receipts, cash disbursements, excess cash
balance, or required total financing.
Parts of the cash budget are as follows:
1. Cash Receipts. These composed of collections from receivables, proceeds from loans,
issuance of new shares of stocks, and advances from the stockholders.
2. Cash Disbursements. These include payments to suppliers and other service providers,
loans, and cash dividends.
3. Excess Cash Balance or Required Total Financing. This part of the cash budget shows
possible funding requirements. If the company has excess cash, it is a good indicator that it
can pay an existing loan or put it in to an investment. If there is no excess cash, the company
must make a plan where to get funds.

ILLUSTRATIVE EXAMPLE:
It was December 2014 and the prresident of DCD Corporation wanted to find out if the
company has enough cash to pay the principal balance of the company’s loan worth P3
million by the end of 2015. He asked the chief accountantant to prepare a cash budget for
2015.
The following assumptions which will be used for the preparation of the cash budget
for 2015 are as follows.
1. Projected quarterly sales for 2015 are as follows:
First quarter - P5 million
Second quarter - P7.5 million
Third quarter - P8.5 million
Fourth quarter - P10 million

Fourth qaurter sales in 2014 was P8 million

90% of the sales are collected in the quarter the sales are made. The remaining 10% is
collected the following quarter.

2. Cost of sales is 75% of sales. Merchandise inventories are purchased in the quarter these
are sold. All merchandise purchased in the quarter are paid in the same quarter.

3. Operating expenses for each quarter paid in cash are as follows:

First quarter - P500,000
Second quarter - P750,000
Third quarter - P850,000
Fourth quarter - P1,000,000

On top of these cash operating expenses, depreciation expense to be charged to

operations is P150,000 per quarter.
 4. Interest expense paid every quarter is P75,000
5. Income tax rate is 30%. The income taxes to be paid every quarter will be as follows:

First Semester - P157,500

Secpnd quarter - P270,000
Third Quarter - P315,000
Fourth quarter - P382,500

6. Expected cash balance at the end of 2014 is about P350,000. For 2015, target cash balance
is raised to P500,000 because of expected increase in sales.

DCD Corporation
Cash Budget
For the year ended December 31, 2015

1ST Quarter 2nd 3rd Quarter 4rth

Quarter Quarter

RECEIPTS (Collections):

Quarter of Sale 4,500,000 6,750,000 7,650,000 9,000,000

A quarter after sale 800,000 500,000 750,000 850,000

TOTAL COLLECTIONS 5,300,000 7,250,000 8,400,000 9,850,000

Less: CASH DISBURSEMENT ( Payments)

Purcahses 3,750,000 5,625,000 6,375,000 7,500,000

Cash Operating Expenses 500,000 750,000 850,000 1,000,000

Income Taxes 225,000 157,500 270,000 315,000

Loan Payment 3,000,000

Interest Expenses 75,000 75,000 75,000 75,000

TOTAL PAYMENTS 4,550,000 6,607,500 7,570,000 11,890,000

Net Cash Flow for the Period 750,000 642,500 830,000 (2,040,000)

Cash Balance, Beginning 350,000 1,100,000 1,742,500 2,572,500

Cash Balance without Financing 1,100,000 1,742,500 2,572,500 532,500

Less: Target Cash Balance 500,000 500,000 500,000 500,000

Cumulative Excess Cash (Funding 600,000 1,242,500 2,072,500 32,500

Requirements)

Note that the depreciation expenses did not enter the cash budget. While it is part of the
operating expenses, it is a non-cash expenses and does not entail any cash outfloe. Hpwever,
since it is a tax-deductible expenses, it can reduce income tax expense and income tax
payments.

Projected Financial Statements

 For the purpose of this chapter, the financial statement method will be used in projecting financial
statement. Based on the approach, the following steps will be followed:
1. Forecast Sales. In making financial projections, always start with the statement of profit or
loss and the most important account to forecast first is sales.
2. Forecast Cost of Sales and Operating Expenses. For the cost of sales, the average cost of
sales over the historical data analyzed can be used. For example, if the average cost of sales for the
past five years is 60% but the management feels that given their plans to improve production
efficiency, cost of sales can be reduced to 58%. In the projection, this 58% cost of sales percentage
can be used. For the operating expenses, try to figure out which are variable and which are fixed.
Variable operating expensesinclude commissions. Fixed operating expenses include depreciation of
office building, salaries and some maintenance expenses.
3. Forecast Net Income and Retained Earnings. To forecast net income, there should be
information on income taxes and how much financing cost a company will have. Financing cost
will be based on the amount of loans the company has and the payment terms for these loans.
There should also be assumptions on the interest rates for the projection period.
4. Determine Balance Sheet items that will vary with sales or whose balances will be highly
correlated with Sales. Balance sheet items that may vary with sales or will be highly correlated
with sales are cash, accounts receivable, inventories, accounts payable, and accrued expenses
payable.
5. Determine payment schedule for Loans. The payment schedule for loans can be based on the
disclosures provided in the notes to financial staements or the plans of management on how to pay
the loans if no details about payment terms are provided in the notes to financial statements.
6. Determine External Funds Needed (EFN). This amount is more of a balancing figure or a
squeeze figure. The balance sheet has to balance. Therefore, after projections are made to project
different balance sheet accounts, the projected statement of financial position has to balance. The
formula for this is:

EFN = Change in total Assets - (Change in Total Liabilities + Total change in

Stockholder’s Equity)

If the EFN is put on the liabilities and stocholders’ equity section and the amount is positive,
this means that there will be additional financing. However, if the amount is negative, this
means that there will be excess cash.
7. Determine how External Funds needed will be Financed. Once EFN is computed, the
management decides how to finance it. It can all be through debt or equity or a combination of
debt and equity.
ILLUSTRATIVE EXAMPLE:
Before the end of 2014, the president of JSC Foods Corporation had instructed the Vice
President for Finance to prepare the 2015 projected financial statements based on their most
recent planning workshop. Based on the results of the planning workshop, the following
assumptions were prepared for the 2015 projected financial statements.
The following assumptions were prepared for the 2015 projected financial statements:
a. Sales are exepected to to increase by 10% in 2015 from the 2014 sales level.
b. The following financial statements accounts are expected to vary with sales based on the
2014 financial statements:
i Cost of Sales
ii Cash
 iii Trade accounts receivables
iv Inventories
v other current assets
vi Trade accounts payable
Variable operating expenses is 7.5% of projected sales. Depreciation expenses is 10% of
the gross beginning balance of property, plant and equipment. As of December 31, 2014, the gross
balance of PPE is P26,000,000. For January 2015, P5,000,000 new PPE will be acquired. It is the
policy of the company that PPE acquired in the first half of the year will be depreciated for one full
year.
c. As of December 31, 2014, there are two long-term loans. Both have annual interest rate of
8%.
i. The first loan will mature on June 30, 2015 and the remaining principal balance
to be paid on June 30, 2015 is P1,250,000
ii. The second loan amounting to P3,000,000 which was incurred on December 31,
2014 is paid at the rate of P500,000 principal balance every June 30 and
December 31. New loans of P3,500,000 will be incurred on December 31, 2015
payable at the rate P500,000 every June 30 and December 31. Annual Interest
rate is expected at 8%

d. Other noncurrent assets and other current liabilities will remain unchanged.
e. Income tax rate is 30% of the income before taxes. Seventy-five percent of the
income
tax expense will be paid in 2015 while the balance will be paid in 2016.
f. Cash dividends of P2,000,000 will be paid for 2015
 STATEMENT OF COMPREHENSSIVE INCOME 2014

Net Sales 52,501,085

Cost of Sales 41,954,730
Gross Profit 10,546,355
Operating Expenses 6,497,659
Operating Income 4,048,696
Interest Expense 250,000
Income before taxes 3,798,696
Taxes 1,139,609
Net Income 2,659,087

STATEMENT OF FINANCIAL POSITION 2014

ASSETS
Current Assets
Cash 1,062,527
Accounts Receivables 2,300,500
Inventories 4,849,403
Other current Assets 1,050,000
Total Current Assets 9,262,331
Noncurrent Assets
Property, Plant and Equipment, Net 12,200,000
Other Noncurrent Assets 835,689
Total Noncurrent Assets 13,035,689
Total Assets 22,298,020

LIABILITIES AND STOCKHOLDER’S EQUITY

Current Liabilities
Accounts Payables 5,050,810
Income Tax Payables 433,051
Current Portion of Long-term Debt 2,250,000
Other Current Liabilities 85,600
Total Current Liabilities 7,819,461

Noncurrent Liabilities:
Long-term Debt, Net of Current Portion 2,000,000
Total Liabilities 9,819,461

STOCKHOLDER’S EQUITY
Capital Stock 8,000,000
Retained Earnings 4,478,559
Total Stockholder’s Equity 12,478,559
Total Liabilities and Stocholder’s Equity 22,298,020

SOLUTION:
1. Forecast Sales:
Net Sales (2014) 52,501,085 x 110% = 57,751,194 (Projected sales)
2. Forecast cost of sales and operating expenses:
 This is how the cost of sales was computed:
Cost of sales percentage in 2014 = ( Cost of Sales (previous year)/
Net sales (previous year) x 100%
= 41,954,730/52,501,085
Cost of sales percentage in 2014 = 79.91%
Projected Cost of sales in 2015 = COS percentage (previous year) x
Projected Net Sales
= 79.91% x 57,751,194
Projected Cost of sales in 2015 = 46,148,979

Variable (7.5% x Sales of 57,751,194) 4,331,340

Fixed (Depreciation Expense) 3,100,000
Total Operating Expenses 7,431,340

Depreciation expense is 10% of the beginning balance of gross PPE of P26 Million and
the new acquisition of PPE worth P5 Million.
The interst expense for 2015 was computed as follows:

First Loan 50,000

Interest from January 1 to June 30, 2015
1,250,000 x 8% x (6/12)

Second Loan 120,000

Interest from January 1 to June 30, 2015
(1,000,000 + 2,000,000) x 8% x (6
months/12 months)

Interest from July 1 to December 31, 2015 100,000

(500,000 + 2,000,000) x 8% x (6 months/12
months
Total Interest Expense 270,000

This is how the following balance sheet accounts were computed:

i. Cash

Cash as a Percentage of Sales in 2014 = Cash (previous year)/Net

Sales (previuos year) x 100%
= 1,062,527/52,501,085
Cash as a precentage of sales in 2014 = 2.02%
Projected Cash in 2015 = cash as percentage of sales in 2019 x
Projected net sales
= 2.02% x 57,751,194
Projected Cash in 2015 = 1,166,574

ii. Accounts Receivable

 Accounts Receivable as a % of Sales in 2014 = Accounts
Receivable (previous year)/Net Sales (previous year) x 100%
= 2,300,500/52,501,085 x 100%
Accounts receivable as a % of Sales in 2014 = 4.38%
Projected Accounts receivable in 2020 = Accounts receivable as
percentage of sales in 2014 x Projected Net Sales
Projected Accounts Receivable in 2015 = 4.38% x 57,751,194

Projected Accounts Receivable in 2015 = 2,529,502

iii. Inventories

Inventories as a % of sales in 2014 = Inventories (previous

year)/Net sales (previous year) x 100%
= 4,849,403/52,501,085 x 100%
= 9.24%
Projected Inventories in 2015 = Inventories as % of Sales x
Projected Net Sales
= 9.24% x 57,751,194
Projected Inventories in 2015 = 5,336,210

iv. Other current assets

Other Curent Assets as a % of Sales in 2014 = Other current assets

(previous year)/Net Sales (previous year) x 100%
= 1,050,000/52,501,085 x 100%
= 2%
Projected other current assets in 2015 = Other current assets as %
of sales x Projected net sales
= 2% x 57,751,194
Projected Other Current Assets in 2015 = 1,155,024

v. Accounts payable

Accounts Payable as a % of Sales in 2014 = Accounts Payable

(previous year)/Net Sales (previous year) x 100%
= 5,050,810/52,501,085 x 100%
= 9.62%
Projected Accounts Payable in 2015 = Accounts payable as a % of
sales x Projected Net sales
= 9.62% x 57,751,194
Projected Accounts Payable in 2015 = 5,555,665

Current Portion of Long-term Debt and Long-term Portion of Long-term Debt.

For the 2020 projected statement of financial position, this will be the breakdown of the
remaining balances of long-term loans as to current portion and long-term portion as of December
31, 2020
 LOAN CURRENT LONG-TERM TOTAL
PORTION PORTION

Loan of P3 million incurred on 1,000,000 1,000,000 2,000,000

December 31, 2014

Loan of P3.5 million to be 1,000,000 2,300,000 3,500,000

incurred on December 31, 2015

Total 2,000,000 3,500,000 5,500,000

External fund Needed (EFN) is just a balancing figure. Below id the formula for computing EFN.
EFN= change in Total Assets – (Change in Total Liabilities + Total change in Stockholder’s
Equity)
EFN = 2,824,980 – (1,614,369 + 730,612)
= 479,998
Refer to the table below for the details of the compu tation of EFN in 2015

2015 Balances without EFN 2014 Balances Change

Total Assets 25,123,000 22,298,020 2,824,980

Total Liabilities 11,433,830 9,819,461 1,614,369

Total Stockholder’s 13,209,171 12,478,559 730,612

Equity

EFN 479,998

SOLUTION:
JSC Food Corporation
Projected Statement of Profit or Loss
For the year ended December 31, 2015

Net Sales 57,751,194

Cost of Sales 46,148,979
Gross Profit 11,602,215
Operating Expenses 7,431,340
Operating Income 4,170,875
Interest Expense 270,000

Income before Taxes 3,900,875

Taxes 1,170,262
Net Income 2,730,613

JSC Food Corproation

Projected Statement of Financial Position
As of the year ended December 31, 2015
ASSETS
Current Assets
Cash 1,166,574
Receivables 2,529,502
Inventories 5,336,210
Other Current Assets 1,155,024
Total Current Assets 10,187,311
Noncurrent Assets
Property, Plant, and Equipment, Net 14,100,000
Other Noncurrent Assets 835,689
Total Noncurrent Assets 14,935,689
Total Assets 25,123,000

LIABILITIES and EQUITY

Current Liabilities
Notes Payable (External Funds Needed) 479,998
Accounts Payables 5,555,665
Income Taxes Payable 292,566
Current Portion of Long-term Debt 2,000,000
Other Current Liabilities 85,600
Total Current Liabilities 8,413,829

Non Current Liabilities

Long-term Debt, Net of Current Portion 3,500,000
Total Liabilities 11,913,829

STOCHOLDR’S EQUITY
Capital Stock 8,000,000
Retained Earnings 5,209,171
Total Stockholders’ Equity 13,209,171
TOTAL LIABILITIES and STOCKHOLDER’S 25,123,000
EQUITY

JSC Food Corporation

Projected Statement of Cash Flows
For the year Ending December 31, 2015
Cash flows from Operations Activities
Income before Taxes 3,900,875
Adjustments:
Depreciation 3,100,000
Changes in the following accounts:
Decrease (Increase) in accounts Receivable (229,002)
Decsrease (Increase) in Inventories (486,906)
Decrease (Increase) in Other Current Assets (105,0240
Increase (Decrease) in Accounts Payable 504,885
Increase (Decrease)in Other Current Liabilities -
Income Taxes Paid (1,310,748)
Cash Flow from Operating Activities 5,374,049

Cash Flow from Investing Activities

Acquisition of PPE (5,000,000)
Acquisition of Ot Noncurrent Assets -
Cash Flow from Investing Activities (5,000,000)

Cash Flows from Financing Activities

Payment of Cash Dividends (2,000,000)
Short-term Notes Payable (EFN) -
Loans, Net of Payments 1,250,000
Cash Flows from Financing Activities (750,000)
Net Change in Cash (375,951)
Cash, Beginning 1,062,527
Cash, Ending 686,576
WORKING CAPITAL MANAGEMENT

WORKING CAPITAL refers to the current assets used in the operations of the business. This includes cash,
accounts receivable, inventories, and prepaid expenses. The amount of resources that a company sets aside to
these working capital accounts can be reduced by current liabilities such as trade accounts payable and
accrued expenses payable. The difference between these current assets and current liabilities used in the
operations of the business is NET WORKING CAPITAL.

GOOD MANAGEMENT OF WORKING CAPITAL ACCOUNTS ALLOWS THE COMPANY TO:

1. To pay maturing obligations on time.

2. Relieves managers of unnecessary stress and gives them more executive time to improve the business
operations.

WORKING CAPITAL FINANCING POLICIES

There are three types of working capital financing policies management can choose from: These are:
1. Maturity-matching working capital financing policy
2. Aggressive working capital financing policy
3. Conservative working capital financing policy

During the year, sales are not the same every month. This is why companies have slack season and peak
season. The net working capital requirements during slack season are lower than those during the peak
season. The net working capital needed to support an operation during the slack season represents the
PERMANENT WORKING CAPITAL REQUIREMENTS while the additional net working capital needed during the
peak season represents the TEMPORARY WORKING CAPITAL REQUIREMENTS.

1. MATURITY-MATCHING WORKING CAPITAL FINANCING POLICY

- permanent working capital requirements should be financed by long-term sources while temporary
working capital requirements should be financed by short-term sources of financing.

2. AGGRESSIVE WORKING CAPITAL FINANCING POLICY

- some of the permanent working capital are financed by short-term sources of financing. Why do managers
of some companies adopt this policy? It is because long-term sources of funds have higher cost as compared
to short-term sources of financing. By financing some of the permanent working capital requirements with
short-term sources of financing, financing cost is minimized which in turn, improves net income. By having this
financing policy, the company is increasing the probability that it will not be able to meet maturing obligations.
In finance, we call this default risk.

3. CONSERVATIVE WORKING CAPITAL FINANCING POLICY

- some of the temporary working capital requirements are financed by long-term sources of financing. Top
management does not probably want to be stressed too much so that they can concentrate their efforts on
other important concerns that will benefit the company. If the company is conservatively financed and good
investment opportunities come along the way. It will be easier for the company to raise additional funds, be it
in the form of debt financing or equity financing.

MANAGEMENT OF WORKING CAPITAL ACCOUNTS

CASH MANAGEMENT
- Cash is the most liquid asset of a company but it is also the asset most vulnerable to theft. Because of
this, there must be proper internal controls over cash that need to be observed to safeguard the
asset. The following internal controls over cash are suggested:

1. Separating Cashiering function from the recording or accounting function. A basic internal control
system should not allow the assignment of custodial function and recording function to one person,
unless you are the owner.
2. Issuing official receipts for collections and summarizing collections in a daily collection report. It is
important to know the collections from business every day as these collections reflect the health of
the company.
 3. Depositing Collections. A good internal control over cash is by depositing all collection intact. The
daily collections reports are now compared with the deposit slips to find out if all collections are
indeed deposited.
4. Adopting the check voucher system for payments. If all collections need to be deposited, then
payment must be made through a check voucher system.

PRIMARY AND SECONDARY REASONS FOR HOLDING CASH:

The amount of cash to be maintained by the company is affected by primary reasons and secondary
reasons.

THE PRIMARY REASONS FOR HOLDING CASH:

1. Transaction Motive: Holding cash are for transaction and compensating balance purposes. Cash is needed
for the day to day operations of the business.

SECONDARY REASONS FOR HOLDING CASH:

2. Precautionay motive or purposes: firm holds cash to be ready in case of unwanted situations such as
slowdown of accounts receivables that may affect the fund for operations.
3. Speculative motive or purposes: A company hold cash for other investment opportunities.

RECEIVABLE MANAGEMENT
Providing credits to a customer is one way of increasing sales and gaining additional customers. Properly
managing the accounts receivable lets the company continue its operations. To minimize loss from accounts
receivable, the customer must be given credit terms and credit evaluation must likewise be done.

The following 5C’s of credit can be used in credit evaluation.

1. Character – is the borrower’s willingness to pay the loan
2. Capacity – is the borrower’s ability to pay the loan
3. Capital – is the borrower’s financial resources
4. Collateral – is the borrower’s security pledge for the loan payment
5. Condition – is the current economic or business conditions.

INVENTORY MANAGEMENT
Inventory is the stocks of the product the business is selling and the parts or raw materials that made up
the product.
Inventory management is very important for manufacturing and merchandising companies especially
companies with perishable products. There should be a sufficient number of inventories to secure the smooth
operations of the business.

The following are the list of internal controls that management should consider in to protect their inventories.
1. Separating the custodial functions from recording functions. The company should not allow the
assignment of custodial functions from recording functions to one person to avoid manipulation of records.
2. Aging of Inventories. It allows the company tp decide what to do with slow-moving items. For example,
they can use bundling or buy one take promo.

3. ABC Analysis. This approach categorize the inventories according to their values. A is considered the most
important inventory or with the highest values, B is considered the average item and C is the least important
or has lower value.