Working Capital

Management

NILO N. IGLESIAS, CPA, MBA, REA

According to The Boston
Consulting Group ……… - The world’s
leading advisor on business strategy

W orking capital is an important

source of cash throughout the
business cycle, but it is especially
critical during a downturn…..
According to The Boston
Consulting Group ……… - The world’s
leading advisor on business strategy

The payoff for effective working capital

management can be even greater during
economic contraction, when reduced access
to external funding and sharp decreases in
sales can greatly limit available cash …..
According to The Boston
Consulting Group ……… - The world’s
leading advisor on business strategy

During a downturn, effective working capital

management can spell the difference
between bankruptcy and solvency or
between acquiring and being acquired –
but too often, companies fail to take
action…
Question: Why is it that too often, companies
fail to take actions regarding focus on working
capital?

According to an article from Finextra.com

(2018), over 75% of companies that are running
at loss or struggling financially would be profitable
and liquid if they were more disposed to
the knowledge and practice of efficient
working capital management
Question: Why is it that too often, companies
fail to take actions regarding focus on working
capital?

In other words, many finance professionals and

business experts often ignore the importance of
managing working capital.
They usually do not go the extra mile in striving
for optimum utilization of resources tied to working
capital.
Probably because, they only look at the work
involved not on its utilization.
Question: Why is it that too often, companies
fail to take actions regarding focus on working
capital?

Hence, there is a need to trace back and utilize the ways of

proper working capital management with the primary objective:
1)Achieving a balance between return and risk
2)Getting your finance in order
3)Not sleeping on receivables
4)Reevaluating your payables
5)Managing your supply chain, among others
Introduction to Working
Capital Management

Part 1
Definition of Working Capital

– For financial analysts, working capital

equals current assets.
– For accountants, working capital equals
current assets minus current liabilities.
– For laymen, working capital is a measure of
a company’s financial strength.
Definition of Working Capital

- It is the “Life blood of every

business concern”
- It also known as “Circulating
Capital”
Current Assets

– Reasonably expected to be realized in

cash or consumed or sold during the
normal operating cycle of the business.
– These include cash, marketable
securities, receivables and inventory.
Current Assets

 Temporary Current Assets

• current assets, such as cash, that fluctuate
with the firm’s operational needs.
 Permanent Current Assets
• the portion of the company’s current assets
required to maintain the firm’s daily
operations. It is the minimum level of
current assets required if the firm is to
continue its operations.
Current Liabilities

– Their liquidation requires the use of current

assets or incurrence of other liabilities.
– They include trade accounts payable,
unearned revenues, accrued expenses,
short-term debts and the current portion of
long-term debt.
Definition of Working Capital
Management

– The administration and control of the

company’s working capital.
– The primary objective is to achieve a
balance between return (profitability) and
risk……
– It measure the liquidity, operational
efficiency and its short-term financial
health
Working Capital Financing
Policies

1. Conservative (Relaxed) Policy

2. Aggressive (Restricted) Policy
3. Matching Policy (Self-liquidating or Hedging
Policy)
4. Balanced Policy
Working Capital Financing Policies
Conservative (Relaxed) Policy
Operations are conducted with too much working capital; involves
financing almost all asset investments with long-term capital.
Advantages:
- reduces risk of illiquidity
- eliminates the firm exposure to
fluctuating loan rates and potential
unavailability of short-term credit
Disadvantage:
- less profitable because of higher
financing cost
Example of Conservative Policy

Current Assets P 450,000

Current Liabilities 100,000
Working Capital 350,000
Permanent Assets 180,000
Temporary Assets 100,000
Total 280,000
Excess Working Capital 70,000
Working Capital Financing Policies
Aggressive (Restricted) Policy
Operations are conducted on a minimum amount of working
capital; uses short-term liabilities to finance, not only temporary,
but also part or all permanent current assets requirement.
Advantage:
- increases return on equity (profitability) by taking advantage
of cost differential between long-term and short-term debt.
Disadvantages:
- exposure to risk arising from low working capital position
- puts too much pressure on the firm’s short-term
borrowing capacity so that it may have difficulty in
satisfying unexpected needs for funds.
Example of Aggressive Policy

Current Assets P 450,000

Current Liabilities 100,000
Working Capital 350,000
Permanent Assets 280,000
Temporary Assets 100,000
Total 380,000
Deficient Working Capital (30,000)
Working Capital Financing Policies
Matching Policy (Self-liquidating or Hedging
Policy)

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.
Working Capital Financing Policies
Balanced Policy

Balances the trade-off between risk

and profitability in a manner consistent
with its attitude toward bearing risk.
Example: Risk-Return Trade-off
Compare the 2 following companies

Firm 1 Firm 2 Firm 1 Firm 2

Marketable securities 0 200 Operating Earnings 150 150
Interest Earned 0 8
Other Current Assets 200 200
EBT 150 158
Fixed Assets 800 800 Taxes 30% (45) (47)
Total Assets 1,000 1,200 Net Income 105 111

Firm 1 Firm 2
Firm 1 Firm 2 Current Ratio 2 4
ST Debt 100 100 ROA 10.25% 9.25%
LT Debt 400 400
Common Stock 500 700 Higher ROA Lower ROA
Total Liab. & Equity 1,000 1,200 Less Liquid More Liquid
Riskier Less Risky
Deciding on an Appropriate
Working Capital Policy
 The amount of net working capital that a company should have
depends on the amount of risk it is willing to take.
 The primary consideration therefore is the trade-off between
returns (profitability) and risk (risks of illiquidity) associated with:
1) Asset Mix Decision- mix of current and non-
current assets.
2) Financing Mix Decision- mix of short-term and long-
term debts to finance current assets.
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.
Rationale of Working
Capital Management
Rationale of Working Capital
Management

 Working capital management or current asset

management is an important part of investment decision.

 Proper management of working capital ensures firm’s liquidity and solvency.

A conflict exists between profitability and liquidity

while managing current asset.
Rationale of Working Capital
Management

 Ifa firm does not invest sufficient funds in current assets, it may
become illiquid and may not meet its current obligations.

 If the current asset are large, the firm would

lose its profitability and but attain liquidity.
 The financial manager should develop proper techniques of managing
current assets so that neither insufficient nor unnecessary funds are
invested in current assets.
 End Results of Effective
Working Capital Management
 Strengthen the Solvency
Operate smoothly without any financial problem
 Enhance Goodwill
Make prompt payment, hence help in creating and
maintaining goodwill
 Easy Obtaining Loan
Because of Good credit rating
 Ability to Face Crisis
Such as during downturn and economic contraction
 End Results of Effective
Working Capital Management
 Regular supply of goods and services
Because of good credit rating from suppliers
 High morale
Confidence in dealing with stakeholders
 Smooth Business Operation
Because of good credit rating and operational
efficiency
 Cash Discount
Availment of cash discount because of prompt
payment
End of Topic
QUESTIONS????

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