Module

G12/ ABM__BF12-lllc-d-10-12 4
MANAGING CASH, RECEIVABLES AND INVENTORY Week
3-4
I What I Need to Know?

1. This module was written for you to accomplish at home. It was carefully
designed so that you can work at your own pace and allow self-discovery
of the concept through activities that you will perform. Activities were
also selected to allow independent learning which also aims to develop
students’ reading comprehension skills through understanding written
texts.
After going through this module, you are expected to:
1. Understand working capital management, net working capital, and
the related trade-off between profitability and risk.
2. Appreciate working capital financing policies and their effects on the
profitability and risk of the company.
3. Compute and analyze the effects of an operating cycle and cash
conversion cycle on the working capital requirements of the company.

D What I Know?
Task 1: Pretest

Instruction: Choose the letter corresponding to the correct answer for each of the
questions provided below. Encircle your answer. (Critical Thinking, Communication and
Collaboration)
1. Which of the following is true about cash management?
a. A cost of holding cash is the liquidity it gives the firm.
b. A cost of holding cash is the interest income earned on the outstanding cash balance.
c. Effective cash management results in minimization of the total interest earnings
involved with holding cash.
d. The primary objective in cash management is to keep the investment in cash as low
as possible while still operating efficiently and effectively.

2. The speculative motive of holding cash refers to:

a. Utilize cash in internal projects
b. Use for any future loss the company is expecting
c. Avail of any future investment opportunity
d. Utilize cash for international project

3. It is called liquid assets which include cash and savings that can be converted to
cash quickly and easily.
a. Fixed Assets b. Current Assets c. Liability d. Equity

4. Net Working Capital is defined as:

a. Total assets minus liabilities b. Total assets minus equity
c. Current assets minus long-term liabilities d. Current assets minus current liabilities

5. Inventory management refers to:

a. management and control of inventory
b. management and control of services, inventory, and equipment
c. control of supplies coming into the organization and supplies used
d. control of materials purchased.

1
Task 2: This is an example of a local Philippine company and its working capital
practices. What are the assets needed by Aldana’s Trading for its daily operations? Refer
your answers to the Statement of Financial Position of Aldana shown below.
Statement of Comprehensive Income
For the Year-ended December 31
2014 2013
Sales 10,040,000 8,760,000
Cost of Goods Sold 5,680,000 5,860,000
Gross Profit 4,360,000 2,800,000
Operating Expenses 1,160,000 1,680,000
Operating Income 3,200,000 1,220,000
Interest Expense 100,000 28,000
Net Income 3,1000,000 1,192,000

Statement of Financial Position

For the Year-ended December 31
2014 2013
Cash 400,000 180,000
Short-term investments 5,600,000 1,800,000
Accounts receivable 1,480,000 1,060,000
Inventory 1,380,000 1,640,000
Other Current Assets 8,860,000 4,680,000
Total Current Assets 10,860,000 5,040,000
Equipment 6,800,000 5,200,000
Total Assets 17,660,000 10,240,000
Accounts Payable 6,600,000 2,620,000
Notes Payable - long term 2,460,000 2,120,000
Owner, Capital 8,600,000 5,500,000
Total liabilities and equity 17,660,000 10,240,000

D What is It?

TOPIC 1: Tools in Managing Cash, Receivables and Inventory

The different Working Capital Assets and their importance in the operations of the
company will be discussed in this module. Working capital is the company’s investment
in current assets such as cash, accounts receivable, and inventories while Net Working
capital is the difference between current assets and current liabilities. This is the flow of
the operating cycle of the business.

The operating cycle is the sum of days of inventory and days of receivables. This is how
to compute the Days of Inventory and Days of Receivables. Days of Inventory or
inventory conversion period or average age of inventories is the average number of days
to sell its inventory.
The formula is:

2
Days of Sales Outstanding (DSO) is the average time for the company to collect its
receivables. - The formula is:

Revenue is from the Statement of Comprehensive Income while Accounts

Receivables is from the Statement of Financial Position. We use the Average Receivables
for the year in our calculation. For revenue, we generally use the credit sales so that we
may have to exclude cash sales from the total sales figure.

The Cash Conversion Cycle is the length of time it takes for the initial cash
outflows for goods and services purchased (materials, labor, etc.) to be realized as cash
inflows from sales (cash sales and in the collection of receivables). The formula for
DPO( Day of Payable Outstanding )is:

To compute Cash Conversion Cycle (CCC), also called the net operating cycle, is
computed as the operating cycle less days of payable. In formula form:
Operating cycle = Days of Inventory + Days of Receivables 3.76+ 7.59 = 11.35
Cash Conversion cycle = Operating Cycle – Days of Payables 11.35 – 293 =
(281.65)

Working Capital Management is the administration and control of the company’s

working capital. The primary objective is to achieve a balance between profitability and
risk. Basically, there are three types of working capital financing policies the
management can choose from:
Maturity-matching working capital financing policy
Aggressive working capital financing policy
Conservative working capital financing policy

Permanent and Temporary Working Capital

Permanent Working Capital is the minimum level of current assets required by a firm to
carry-on its business operations given its production capacity or relevant sales range.
Temporary working capital is the excess of working capital over the permanent working
capital given its production capacity or relevant sales range.
The Working Capital Financing Policies Financing policies can either be
aggressive, conservative or maturity-matching:

Aggressive Working Capital Financing Policy

• Under the aggressive working capital financing policy, some of the permanent working
capital requirements are financed by short-term sources of financing.

3
 • 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.
• But what is the trade-off? Since it is short-term, the debt has to be paid soon and the
company may not yet have enough cash by the time the debt matures. This refers to
liquidity risk and this risk increases with the aggressive working capital financing policy

Conservative Working Capital Financing Policy

• Based on the conservative working capital financing policy, even some of the
temporary working capital requirements are financed by long-term sources of financing.
• This policy minimizes liquidity risk but it also reduces the company’s profitability
because long-term sources of financing entail higher cost.

Maturity-matching working capital financing policy

• Based on the 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.
• Long-term sources of financing include long-term debt and equity such as common
stock and preferred stock. Short-term sources include short-term loans from a bank.
• These short-term loans from banks are called working capital loans which perfectly
describe the reasons why these loans are incurred.

The strategies for managing the cash conversion cycle.

• The central issue in managing the working capital is the ability to reduce operating
cycle days. This is to ensure that such operating cycle days will be shorter than the
payable days. The quickness of completing the operating cycle is measured by the
operating cycle days.
• The following are some of the strategies in efficiently managing the cash conversion
cycle:
1. Turn over inventory as quickly as possible without stock-outs that result in lost
sales. 2. Efficiently manage the accounts receivable consistent with the company’s
credit policies. You need to also consider accelerating the collection of receivables
through:
A. Shorter credit terms.
B. Offering special discounts to customers who pay their accounts within a
specified period.
C. Speeding up the mailing time of payments from customers to the firm.
D. Minimizing the float or reducing the time during which payments received by
the firm remain uncollected funds. For example, a customer deposited a check in the
name of the company on a Friday and the check will be cleared on Monday. The
payment is said to be floating for two days.
3. Manage mail, processing, and clearing time to reduce them when collecting from
customers and to increase them when paying suppliers.
4. Pay accounts payable as slowly as possible without damaging the firm’s credit rating.

E What’s More?

Task 3 Directions: Choose the letter corresponding to the correct answer for each of
the questions provided below.
1. What is a Working capital management?
a. It is the placement of the firm’s debt and equity issues.
b. It is the financing and management of the firm’s current assets.
c. It is also known as inventory management.
d. It is the management of the firm’s capital assets.

2. What is the transactional motive of holding cash?

a. To keep a cash reserve for purchasing goods and services to balance out the cash
inflows and outflows.

4
b. To keep the cash for all the transactions made during a periodic term.
c. To keep the cash for transactions mandatory for day to day activities.
d. To keep the transactions for foreign trading.

3. Below are all components of working capital except:

a. Cash b. Marketable Securities c. Inventories d. Notes Payable

4. In what order will a company’s current assets appear on a classified balance sheet?
a. Alphabetical order c. From largest to smallest amount
b. Company’s choice d. Order of Liquidity

5. Which of the following would not be important in examining the firm's buildup of
accounts receivable, cash, and current assets:
a. A brief cash budget c. Income Statement
b. Cash receipts and cash payments schedules d. Sales forecast

Task 4 Directions: Answer the following question.

Philippine Products Company is concerned about managing cash efficiently. On the
average, inventories have an age of 90 days and accounts receivable are collected in 60
days. Accounts payable are paid approximately 30 days after they arise. The firm has
annual sales of about PHP30 million. Assume there is no difference in the investment
per peso of sales in inventory, receivables, and payables and that there is a 360-day
year.
1. Calculate the firm’s operating cycle.
2. Calculate the firm’s cash conversion cycle.
3. Discuss how management might be able to reduce the cash conversion cycle.

E What can I Engage In?

Task 5: APPLYING THE ANALYSIS

Directions: Answer question 1-5 based on the following information.
Account Beginning Balance Ending Balance
Account Receivable (net) P200,000 P250,000
Inventory 125,000 75,000
Account Payable 100,000 50,000
Sales (all on credit) 1,800,000
Cost of Sales 2/3 of sales
Number of working days 360

1. What is the account receivable turnover?

2. What is inventory turnover?
3. What is the account payable turnover?
4. What is the operating cycle?
5. What is the cash conversion cycle?

A What I have Learned?

Working capital is the company’s investment in current assets such as cash,
accounts receivable, and inventories while Net Working capital is the difference between
current assets and current liabilities. Working Capital Management is the administration
and control of the company’s working capital whose objective is to achieve a balance
between profitability and risk.
There are three types of working capital financing policies: (1) Maturity matching
working capital financing policy; (2) Aggressive working capital financing policy; and (3)
Conservative working capital financing policy.
Cash, being the most liquid asset, is an important account in the balance sheet
that will affect the liquidity, and solvency of a company. It is also the most vulnerable

5
when it comes to theft. A good internal control must be properly implemented to safeguard
this asset.
Accounts receivables spring out of the need to sell merchandise. An excellent
business proposition is to generate sales without offering a credit facility to customers.
However, this concept is theoretically sound, but not sustainable. Proper management of
accounts receivable entails having a good billing and collection system.

Task 6: Direction: Solve the following problems and present your solutions below:
1. If a company has current assets of Php 530,000 and current liabilities of Php
300,000 the amount of its working capital is _______________________.

2. Ninety percent (90%) of Dove Bird Seed’s total sales of Php 600,000 is on credit. If its
year-end receivables turnover is 5, the average collection period (based on a 365-day
year) is __________________.

3. Using the data provided on No. 2, its year-end receivable is __________________.

4. Paula owns and operates an apparel store. Examine her current assets and liabilities
below and compute her net working capital. ______________________.
Cash Php 10,000 Accounts Payable Php 7,500
Accounts Receivable 5,000 Accrued Expense 2,500
Inventory 15,000 Other Trade Debt 5,000

5. The days’ sales in inventory is 73. The cost of goods sold is 720,000. The net sales are
Php 1,020,000, The beginning inventory was 82,000. What is the ending inventory?
____________________

A What I can Do?

Task 7: (Collaboration and Critical Thinking)

Directions: Write TRUE if the statement is CORRECT; Write FALSE if the statement is
INCORRECT.
__________1. Working capital is the same as net working capital.
__________2. The amounts needed to compute a company’s working capital come from
Income Statement.
__________3. The operating cycle for most companies will be longer than one year.
__________4. Accounts Receivable affects the working capital of a company.
__________5.Time as consideration is unimportant in inventory management.
__________6. Current assets should always be financed by current liabilities.
__________7. Account receivable is also known as notes receivable.
___________8. The financial manager of a firm is mostly interested in the company’s
available balance, not its book balance of cash.
__________9. In accounts receivable management, credit analysis is the process of
determining the probability that customers will not pay.
__________10. Current asset is the asset that can be converted into cash within one
year.

References:
Books
Cayanan, A. & Borja (forthcoming). Business Finance. Quezon City. Rex Bookstore.
Gitman, L. J. & Zutter C. J. (2012), Principles of Managerial Finance (13th Ed), USA: Prentice-Hall
https://smallbusiness.chron.com/business-financing-problems-292.html. Retrieved June 17,
2020 https://www.investopedia.com/terms/c/corporatefinance.asp. Retrieved June 17, 2020

6
https://corporatefinanceinstitute.com/resources/knowledge/finance/corporate-finance-
industry/. Retrieved June 17, 2020
https://www.cleverism.com/corporate-finance-essentials
Websites
https://smallbusiness.chron.com/business-financing-problems-292.html
https://en.wikipedia.org/wiki/Indirect_finance
Acknowledgment
Writer: Edna B. Waje , DEM Ellaine I. Dela Cruz, DBA
Editor: Isabel A. Gumaru, DBA
Evaluator: Ellaine I. Dela Cruz, DBA
Validators & Reviewers: Remylinda T. Soriano, EPS Angelita Z. Modesto, PSDS George G.
Borromeo, PSDS
Management Team : Maria Magdalena M. Lim, Schools Division Superintendent, Manila Aida H.
Rondilla, Chief Education Supervisor Lucky S. Carpio, EPS in charge of LRMDS Lady Hannah C.
Gillo, Librarian II, LRMDS