Chapter 1

Concepts in Working Capital

Management

CACF 450 – N. Kirsh, CPA, MBA, CBV

Adapted from Working Capital Management: Applications and Cases, James S. Sagner
(Copyright ©2014 by John Wiley & Sons, Inc. All rights reserved.)
Foreward
 Working capital management is the art —
and increasingly the science—of organizing
a company’s short-term resources to
sustain ongoing activities, mobilize funds,
and optimize liquidity
 Net working capital is loosely defined, but is

generally
◦ Current assets less current liabilities; or
◦ AR + Inv. - AP
Guiding principals
 The efficient utilization of current assets and
current liabilities of a firm throughout each
phase of the business operating cycle.
 The planning, monitoring, and management of
the company’s collections, disbursements, and
bank account balances.
 The management of receivables, inventories,
payables, and international transactions to
minimize the investment in idle resources.
 The gathering and management of information to
effectively use available funds and identify risk.
Why this class exists
 Textbook (US) Focus: wake of credit
markets in 2008; bankruptcies; business
expansion
 Our (McGill) focus:

◦ Accounting: advising on short term financial

management; understanding the FR impacts
◦ Finance: corporate finance and budgeting
 Career emphasis:
◦ Controllers, auditors, analysts, consultants,
bankers, IT/marketing specialists, managers
Our approach
 Most even weeks are theory – do the required
readings!
◦ Bite size chapters of approximately 5,000 words
 Odd weeks are cases
◦ Prepare the cases in advance – there is a participation mark.
◦ One group will be called on per week to present their
findings.
◦ Course outline is the approximate schedule - there will
inevitably be overlap between theory and cases
 Strong emphasis on practical aspects and Excel –
practice speed and technique!
 Bonus marks available!
Learning Objectives
 Explanation of the basic concepts of working
capital
 Appreciation for the problems in assigning

management responsibility for working capital

 Consideration of traditional and modern ideas

of working capital management

 Understanding the essential focus of cost in

working capital management

 Applying working capital concepts to a

successful company–Best Buy

What Is Working Capital?
 The arithmetic difference between two
balance sheet aggregated accounts: current
assets and current liabilities
 The calculation is done in a currency, such as

CAD
 The balance sheet that follows shows the

relevant accounts used in calculating working

capital Applying working capital working

Source: J. M. Bryson (2010) “The Future of Public and

Nonprofit Strategic Planning in the US,” Public
Administration Review, Supplement to Volume 70, p.
S295.
 Exhibit 1-1: Rengas Company Balance Sheet
As of December 31, 2013
(Working Capital Accounts in red)

Assets Liabilities and Owners Equity

Current Assets $65,000,000 Current Liabilities $22,500,000

Cash 5,000,000 Accounts Payable 15,000,000

Short-Term
15,000,000 Notes Payable 6,000,000
Investments
Accounts
27,500,000 Accrued Expenses 1,500,000
Receivable
Inventory 15,000,000 Second level heading
Prepaid Expenses 2,500,000 Long-Term Liabilities 36,500,000

Fixed Assets 60,000,000 Owners’ Equity 56,200,000

Description of Working Capital Accounts - I

 Cash: cash on hand and in bank accounts, and

short-term investments that are expected to be
turned into cash within one year (Chapters 3-5)
 Accounts receivable: credit sales in which the

customer is expected to pay by a future date

specified on an invoice (Chapter 6)
 Inventory: raw materials, work-in-process, and

finished goods (Chapter 7)

Description of Working Capital
Accounts - II
 Payables: accounts payable represents the
amounts owed to creditors for purchases;
payroll is also discussed (Chapter 8)
 Other working capital accounts (not specifically
discussed in subsequent chapters):
◦ Prepaid expenses (asset): assets paid in advance of
expenses as incurred, such as insurance paid in
advance of the incurrence of the expense
◦ Accrued expenses (liability): costs that have been
incurred as of the date of a balance sheet but not
paid, such as payroll for employees whose expense
has been incurred but not yet paid
Basic Working Capital Ideas
 Banks: includes commercial banks, other financial
institutions, and vendors providing working capital
services
 Cost of capital (weighted average cost of capital, or
WACC) used to value float
◦ The WACC is the weighted average of a firm’s cost of debt
(after tax) and cost of equity (common stock and retained
earnings) and is expressed as a percentage
 Float is critical to an understanding of working
capital
◦ Refers to funds in the process of collection or disbursement
◦ Lockboxing is relatively antiquated and primarily US
The “Missing” Working Capital Manager

 Consideration of working capital not typically

been a major focus for management
◦ For this reason, companies “default” responsibility to
finance, where cash and capital reside
 Presents a dilemma for any manager attempting
to improve working capital
◦ Violating someone else’s “turf” or area of
responsibility may prevent the appropriate action or
the necessary cooperation from occurring
Payment Steam Matrix - I
 Preparation of a draft "payment stream matrix"
listing working capital flows by name, dollar
volume, and manager
◦ Becomes a kind of road map to understanding and
improving the business by indicating those major
activities that drive successes and failures
◦ See next page for example
◦ Brings other functions within an organization into the
working capital review
 Necessary to involve managers in all disciplines of the
business, including sales, operations, and finance; and
input from customers and vendors
Payment Steam Matrix - I

◾ Inflows, or collection flows,

usually result from the sale of
products or services, although
collections can occur from
interest income, the sale of fixed
assets, and other sources.
◾ Outflows, or disbursement
flows, are accounts payable to
vendors for purchases), payroll,
payments on fixed debt, and
other uses of cash.
Payment Steam Matrix - II
 Revisions to the matrix are expected to improve the
quality of the information that is developed
 Focus on the major inflows and outflows—usually those
$1 to 2 million or more per month in activity
 Overcome resistance by:
 Involving senior management
 Rewarding employees who work outside of finance for their
ideas
 Internally publicizing the effort
Traditional and Modern Working
Capital
 Working capital traditionally has been
considered as a positive component of the
balance sheet
◦ Constitutes a store of value
 Modern attitude is that it constitutes a drag on
financial performance
◦ Emphasis now is on reducing current asset accounts
so that current liabilities can be funded from the on-
going operations of the business
◦ Requires active management of assets and liabilities
Cost as the Working Capital Issue

 Important cost factors include:

◦ Managing the entire timeline of a business process in
order to achieve major cost savings
◦ Optimizing cost efficiency using scenario
methodology that determines the costs of the various
operational processes for handling a business process
◦ Seeking additional methods to capture working capital
cost efficiencies
 Involves constructing a working capital timeline
(see next slide)
Working Capital Timeline - I
Sales/Mktg
Receive/Enter Order Funds Available
Ship Order/ Deposit Check
Deliver Send
Service Invoice Receive Check
(Credit Policy)
(Payables
Policy)
Receive Draw Check
Invoice
Mail Check

Place Order Check Clears

Vendor Selection
Working Capital Timeline - II
 A change to only one element along the
timeline is flawed for the following reasons:
◦ Unseen solutions
◦ Objective evaluation
◦ Timeline element interactions
 Float: funds in the process of collection or
disbursement
◦ While the complete elimination of float is impossible,
the calculation of the amount of float is critical in
considering alternative processes
◦ Consider impact of WACC on basic WCR assumptions
Float and Processing Expenses
 Float involves funds in the process of collection
or disbursement, activities that have inherent
delays that are costly for a company
 Processing expenses: each transaction along

the timeline—whether performed internally or

outsourced—has a cost that directly impacts a
company’s profitability
Working Capital at Best Buy - I
 A “category killer” business
◦ A key to this model is inventory, involving the
ordering process, transportation, and warehousing
◦ Highly automated in modern distribution centers
using bar coding equipment to scan and direct
merchandise to holding bins or directly for delivery to
stores
◦ As inventory is sold, computerized information
notifies distribution to begin replenishment and
marketing to match sales versus projections
◦ Working capital ratios indicate superior performance
compared to the industry
Working Capital at Best Buy - Textbook
Best Buy Industry Median
2012 2009 2012 2009
Current ratio (to 1) 1.3 1.0 1.2 1.3
Quick ratio (to 1) 0.6 0.4 0.6 0.6
Receivables turnover 19.8 22.9 10.2 19.6
(turns per year)
Inventory turnover 5.7 7.2 7.2 6.6
(turns per year)
Return on equity (%) 20.5 22.0 15.3 17.4
Working Capital at Best Buy – 2021 Update
Best Buy - Liquidity
2.0
1.4 1.5 1.4 1.5
1.5 1.3 1.2 1.2
1.1
1.0 0.8
0.7 0.7 0.6
0.6 0.6
0.4 0.4
0.5

-
FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 FY2021

Current Ratio Quick Ratio

Best Buy - Efficiency/ Performance

50.0 50.0 %
41.5 42.8
40.3
40.0 35.2 40.0 %
31.2 32.4 31.4
30.0 30.0 %
20.2
20.0 20.0 %

10.0 5.2 5.9 5.9 6.0 6.4 6.2 6.3 6.8 10.0 %

- -
FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 FY2021

Receivables T/O Inventory T/O Return on equity

Source: Capital IQ Research Database

Working Capital at Best Buy - Comments
 Liquidity decreasing
 Turnover increasing
 Return on equity increasing
 COVID-19 Impacts
 E-commerce?

 Other comments?