WORKING CAPITAL, CASH AND RECEIVABLE MANAGEMENT

WORKING CAPITAL MANAGEMENT  It becomes difficult for firm to exploit favorable

market conditions and undertake profitable
 management of current assets and current
projects due to lack of working capital.
liabilities
 The rate of return on investments also falls with
 Current assets include inventory, accounts
shortage of working capital.
receivable, marketable securities, and cash.
 The firm cannot pay day-to-day expenses of its
 Current liabilities include notes payable,
operations and it created inefficiencies,
accruals, and accounts payable.
increases costs and reduces the profits of
The management is to ensure that the firm has business.
adequate working capital to run its business
CASH CONVERSION CYCLE
operations smoothly.
 the length of time required for a company to
It should have neither excess working capital
convert cash invested in its operations to cash
nor inadequate working capital.
received as a result of its operations
 Cash – enough to support firm's operation
Calculating the Cash Conversion Cycle
 Accounts Receivable – not to be too lax nor
too strict in granting credits firm's operating cycle (OC)
 Inventories – enough to support market
 the time from the purchase of inventories to
demand
collection of cash from the sale of these
 Current liabilities – be prudent in making use
inventories
of the time before it finally pays off its
 It is measured in elapsed time by summing the
obligations
average age of inventory (AAI) or average
EXCESSIVE WORKING CAPITAL selling period (ASP) and the average collection
period (ACP).
 Excessive working capital means idle funds
which earn no profits for business and hence OC = ASP + ACP
business cannot earn a proper rate of return.
 However, the process of producing and selling
 When there is a redundant working capital it
a product also includes the purchase of
may lead to unnecessary purchasing and
inventories on account, which results in
accumulation of inventories causing more
accounts payable.
chances of theft, waste and losses.
 Average payment period (APP) - the time it
 It may result into overall inefficiency in
takes to pay the accounts payable, measured in
organization.
days
 Due to low rate of return on investments, the
 The operating cycle less the average payment
value of shares may also fall.
period yields the cash conversion cycle. The
 The redundant working capital gives rise to
formula for the cash conversion cycle is:
speculative transaction.
 Relations with banks and other financial CCC = OC- APP
institutions may not be maintained.

INADEQUATE WORKING CAPITAL

 Inability to pay its short-term liabilities in time.

Thus, it will lose its reputation and will not be
able to get good credit facilities.
 It cannot buy its requirements in bulk and
cannot avail of discounts.
PROBLEM 1

In its 2017 annual report, Luzvimin Corporation

reported that it had revenues of P18 billion, cost of FUNDING REQUIREMENTS OF THE CASH
goods sold of P16.8 billion, accounts receivable of CONVERSION CYCLE
P2.4 billion, inventory of P2.1 billion and accounts
1. permanent funding requirement
payable of P1.25 billion. Total purchases for the
 investment in operating assets resulting
year was P11.25 billion. (Use 360 working days)
from constant sales over time
Determine the cash conversion cycle. 2. seasonal funding requirement
 an investment in operating assets that
varies over time as a result of cyclic sales

EXAMPLE:

7RS holds, on average, P50,000 in cash

and marketable securities, P1,250,000 in inventory,
and P750,000 in accounts receivable. 7RS's
business is very stable over time, so its operating
assets can be viewed as permanent. In addition,
7RS's accounts payable of P425,000 are stable
PROBLEM 2 over time.
The balance sheet of Olive Industries for December Thus, 7RS has a permanent investment in
31, 2016 contains the following. The amounts also operating assets of P1,625,000 (P50,000+
pertain to the average for the year. Use 360 P1,250,000+ P750,000 - P425,000). That amount
working days. would also equal its permanent funding
requirement.

Sales for the year amounted to P720,000/ Mark up

on cost is 60%.

1. What is the working capital?

2. Determine the cash conversion cycle.
Cash Conversion Cycle: Aggressive vs. PROBLEM 4
Conservative Seasonal Funding Strategies
Alivia Corporation has a permanent funding
1. aggressive funding strategy requirement of P250,000 in operating assets and
 a funding strategy under which the firm seasonal funding requirements that vary up to
funds its seasonal requirements with short- P1,100,000 and average P180,000.
term debt and its permanent requirements
Alivia can borrow short-term funds at 7% and long-
with long-term debt
term funds at 9%, and it can earn 6% on the
2. conservative funding strategy
investment of any surplus balances.
 a funding strategy under which the firm
funds both its seasonal and its permanent 1. What is the annual cost of an aggressive
requirements with long-term debt strategy for seasonal funding?
2. What is the annual cost of a conservative
strategy for seasonal funding?
Aggressive Funding Conservative
Strategy Funding Strategy
 seasonal  seasonal
requirements with requirements with
short-term debt long-term debt
 permanent  permanent
requirements with requirements with
long-term debt long-term debt

PROBLEM 3

USANA Company has a permanent funding

requirement of P300,000 in operating assets and
seasonal funding requirements that vary between
PO and P800,000 and average P250,000. PROBLEM 5
USANA can borrow short-term funds at 6.5% and Roxas Company has a permanent funding
long-term funds at 9%, and if it can earn 5% on the requirement of P400,000 in operating assets and
investment of any surplus balances. seasonal funding requirements that vary up to
Then, the annual cost of an aggressive strategy for P600,000 and average P120,000. Roxas can
seasonal funding will be: borrow short-term funds at 6% and long-term funds
at 8%, and it can earn 5% on the investment of any
surplus balances.

Which funding strategy would be less costly? What

is the net advantage?
  Processing float
 from the time the check is received by the
REASONS FOR MAINTAINING CASH
payee until the time it is deposited in the
1. Transaction Motive payee's bank account
2. Speculative Motive  Clearing float
3. Precautionary Motive  from the date the check is deposited up to
the date the check is cleared and made
POSSIBLE PLACEMENTS FOR EXCESS CASH available for use
1. Savings and/or currents accounts REDUCING COLLECTION FLOAT
2. Time deposits
3. Stocks 1. Collecting center or agent
4. Treasury bills
PROBLEM 6
5. Commercial papers
6. Pay long-term liabilities GGEM Corporation has an agreement with Security
7. Money market placements Bank Corp (SBC) to collect P3,000,000 a day in
8. Purchase fixed assets exchange for a compensating balance of P500,000.
9. Enter in a new profitable venture The firm, with a significant increase in its customer
in the area, is thinking of cancelling the agreement
CONTROLLING CASH FLOWS
and dividing the service provided by SBC with
1. Synchronizing cash flow China Bank, Inc (CBI).
2. Cash floats on
With this plan, SBC will handle the collection of
a. payments
P2,000,000 with a compensating balance of
b. collections
P800,000. On the other hand, CBI bank will handle
3. Extending cash payment
the other P1,000,000 collection in exchange for a
4. Availing of cash discount
compensating balance of P400,000. With the
5. Optimum transaction size
planned arrangement with the two banks to perform
FLOAT the collection, the firm is expecting to reduce the
collection period by one day. The firm's rate of
 Disbursement and Collection float return is 7%.
 Bank vs Book balances
 Net float What is the amount of incremental income or loss if
 is the sum of disbursement float and GGEM will pursue the division of service between
collection float SBC and CBI?
 Float management
 involves controlling the collection and
disbursement of cash. The objective in cash
collection is to reduce the lag between the
time customers pay their bills and the time
the checks are collected
 Mail float
 from the time the check is issued up to the
time the check is received by the payee
 the part of the collection and disbursement
process where checks are trapped in the
postal system
 PROBLEM 8
2. Reducing Collection Float Lockbox System ABC company is a retail mail order that currently
uses a central collection system that requires all
PROBLEM 7
checks to be sent to its headquarters. An average
It takes CELLSENTIALS several days to of 6 days is required for mailed checks to be
receive and deposit collections from customers to received, 3 days to process them and 2 days for
its three banks. Therefore, lockbox system is being the checks to clear through its bank. A proposed
considered. The bankers explain that with the lockbox system would reduce the mailing and
system in place, the expected float time will be processing time to 2 days and the check clearing
reduced. The following shows the packages offered time to 1 day. An entity has an average daily
by the banks: collection of P150,000.

How much would be the increase in the average

cash balance if the company adopts the lockbox
system?

1. How much is the advantage (disadvantage) of

the lockbox system offered by China?
2. How much is the advantage (disadvantage) of
the lockbox system offered by Land?
3. How much is the advantage (disadvantage) of 3. Concentration Banking
the lockbox system offered by Metro?
A firm doing business over a wide geographical
area normally maintains several accounts in
different banks.

a. payroll of employees
b. payments to the suppliers
c. receipts of collections from customers

4. Wire Transfer

Society for Worldwide Interbank Financial

Telecommunication.

EXTENDING CASH DISBURSEMENTS

1. Playing the Float

 the process of taking advantage of the
clearing system in order to make use of the
funds in the firm's bank account
2. Auto-Debit Transfer Assume that the fixed cost of selling marketable
 a bank service provides the firm two or securities is P10 per transaction and the interest
more accounts to facilitate payments and rate on marketable securities is 8% per year. The
collections: Savings and Current Account company estimates that it will make cash payments
(demand or checking account) of P12,500,000 per quarter.
 the current account is maintained with zero
Determine the following:
balance, all payments to be made by the
firm are through checks and all deposit or 1. optimal transaction size
collections will be made on the savings 2. average cash balance
account 3. the number of times (during the year) the
 when a check issued by the firm is company has to convert marketable securities
presented to the bank, the amount to be to cash
charged to the current account will be 4. the total cost of converting marketable
funded automatically by the savings account securities to cash
3. Debit Transfer 5. the total carrying cost of cash
4. Stretching of Payables
5. Centralization of disbursements
 firms could monitor their payments and
satisfy their obligations to the optimum time
 firms can select creditors who must be paid
first and extend payments to those who can
tolerate delays

OPTIMAL TRANSACTION SIZE

PROBLEM 9

A company generates P10,000 per month excess

cash, which it intends to invest in short-term
securities. The interest rate it can expect to earn on
its investment is 5% per annum. The transaction
costs associated with each separate investment of
funds is constant at P50. What is the total cost
associated with the ECQ?

RECEIVABLE MANAGEMENT

Objective:

To collect accounts receivable as quickly as

possible without losing sales from high-pressure
collection techniques.

Accomplishing this goal encompasses THREE

topics:

A. credit selection and standards

B. credit terms
C. credit monitoring

A. CREDIT SELECTION AND STANDARDS

PROBLEM 10
Credit standards are a firm's minimum  the number of days after the beginning of the
requirements for extending credit to a customer. credit period until full payment of the account is
due
The five C's of credit are as follows:
Increasing a firm's credit period from net 30 days to
1. Character: The applicant's record of meeting
net 45 days should
past obligations.
2. Capacity: The applicant's ability to repay the 1. increase sales, positively affecting profit
requested credit. 2. increase investment in accounts receivable,
3. Capital: The applicant's debt relative to equity. negatively affecting profit
4. Collateral: The amount of assets the applicant 3. bad-debt expenses would also increase,
has available for use in securing the credit. negatively affecting profit
5. Conditions: Current general and industry- D. CREDIT MONITORING
specific economic conditions, and any unique  the ongoing review of a firm's accounts
conditions surrounding a specific transaction. receivable to determine whether customers are
paying according to the stated credit terms
B. CREDIT TERMS
 If they are not paying in a timely manner,
 the terms of sale for customers who have been credit monitoring will alert the firm to the
extended credit by the firm problem.
 Slow payments are costly to a firm because
cash discount they lengthen the average collection period
 a percentage deduction from the purchase and thus increase the firm's investment in
price; available to the credit customer who pays accounts receivable.
its account within a specified time Credit Monitoring Techniques:
EXAMPLE: 1. average collection period
 terms of 2/10 net 30 2. aging of accounts receivable
 the customer can take a 2 percent discount Average Collection Period
from the invoice amount if the payment is made
within 10 days of the beginning of the credit It has two parts:
period or can pay the full amount of the invoice
1. The time from the sale until the customer mails
within 30 days
the payment.
cash discount period 2. The time from when the payment is mailed until
the firm has the collected funds in its bank
the number of days after the beginning of the credit account.
period during which the cash discount is available
aging schedule
If a firm were to increase its cash discount period
10 days (from 2/10 net 30 to 2/20 net 30)  a credit-monitoring technique that breaks down
accounts receivable into groups on the basis of
1. Sales would increase, positively affecting profit their time of origin
2. Bad-debt expenses would decrease, positively  indicates the percentages of the total accounts
affecting profit receivable balance that have been outstanding
3. The profit per unit would decrease as a result of for specified periods of time
more people taking the discount, negatively
affecting profit.

credit period
 1. How much is the increase in profit contribution
from the sales?
2. How much is the cost of marginal investment in
accounts receivable?
3. How much is the cost marginal bad debt?

Some Collection Techniques

1. Letters
2. Telephone calls
3. Personal visits
4. Collection agencies
5. Legal actions

Changes in Credit Policy

PROBLEM 2: CREDIT POLICY STRICTER

Kisha Company has annual credit sales of P4

million. Its average collection period is 40 days and
bad debts are 5% of sales. The credit and
collection manager is considering instituting a
stricter collection policy, whereby bad debts would
To Assess the Effect of Changes in Credit be reduced to 2% of total sales, and the average
Policy collection period would fall to 30 days. However,
sales would also fall by an estimated P500,000
annually. Variable costs are 60% of sales and the
cost of carrying receivables is 12%. (Assume 360
days a year)

1. How much is the decrease in profit from the

sales?
2. How much is the savings from marginal
investment in accounts receivable?
PROBLEM 1: CREDIT POLICY - RELAXED 3. How much is the savings from marginal bad
debt?
The Sales Director of Sweet Bites suggests that
certain credit terms be modified. He estimates that
sales will increase by at least 20% and accounts
receivable turnover will be reduced to 8 times from
the present turnover of 10 times. Bad debts, now at
1% of sales will increase to 1.5%. Sales before the
proposed changes is at P900,000. Variable cost
ratio is 55% and desired rate of return is 20%.
Fixed expenses amount to P150,000.
ANSWERS:

1. P200,000
2. P11,000
3. P130,000

PROBLEM 3: CREDIT POLICY - RELAXED

PROBLEM 4: CREDIT POLICY - STRICTER
Assume that your firm is considering relaxing its
current credit policy. Currently the firm has annual Lodi Optical, Inc, offers branded designer
sales, all credit, of P16 million and an average prescription eyeglasses. All sales are currently on
collection period of 30 days. The firm is considering credit and with no cash discount. The firm is
a change in credit terms from the current terms of considering a 2 percent cash discount for payment
net 30 to 1/30 net 60. The change is expected to within 10 days. The firm's current average
generate additional sales of P2 million. The firm collection period is 90 days, sales are 700 units per
has variable costs of 75% of the selling price. The year, selling price is P25,000 per unit, variable cost
information provided here, plus additional per unit is P18,750, and the average cost per unit is
information, is summarized in the table below. P21,000. The firm expects that the change in credit
terms will result in a minor increase in sales of 15
units per year, that 75 percent of the sales will take
the discount, and the average collection period will
drop to 72 days. The firm's bad debt expense is
expected to become negligible under the proposed
plan. The bad debt expense is currently 0.025
percent of sales. The firm's required return on
equal-risk investments is 20 percent. (Assume a
If the credit policy is made, determine the following: 360-day year.)

1. change in bad debt losses 1. What is the marginal investment in accounts

2. change in profit contribution receivable under the proposed plan?
3. additional investment in accounts receivable 2. What is the cost of marginal investment in
4. the cost of the additional investment in accounts receivable under the proposed plan?
accounts receivable and inventory 3. What are the savings of marginal bad debts
5. the change in the cost of the cash discount will under the proposed plan?
be 4. What is the cost of the marginal cash discount?
6. the net effect 5. What is the net result of increasing the cash
discount?