Working Capital and Cash Flow Management

What is Working Capital?
Working capital is a portion of the firms’ capital continuously converted to cash fund, from its inventories, to account receivables to cash.

Examples of working Capital are:
Firm’s safe Cash
Checks for encashment
Bank account balances
Marketable securities
Notes and accounts receivables
Prepaid expense and deferred items

Importance of working Capital:
Inventory replenishment
Provision for operating expense
Back up for credit sales
Safe Margin

The amount of cash needed by the firm depends on:
The firm’s purchases and cash sales
The time period between credit sales and collection
Purchase of raw materials
Payment of salaries
Account receivable collection
Amount needed for inventory investment
Amount needed for other purpose such as payment of dividends

Cash Management activities:
* Effective cash management adhere to the principle that idle cash earns nothing.
*If sufficient amount of profit must be attained, cash should be invested.
* Sufficient cash may mean covering the firms cash expenditures.

Since companies cannot avoid credit sales, liquidity is a primary concern of effective business finance.

Liquidity Management Activities:
*The unpaid portion of credit sales is represented by accounts receivable in the firm’s records.
*The collection of accounts receivables from customers contributes to the cash inflow required by the firm.
* it requires maintenance of sufficient amount of cash to cover the cash requirement of the company from various sources such as:
– Cash sales
– Collection of accounts receivables
– Loans
– Sales of Assets
– Ownership contribution
– Advances from customers

Working Capital must attain the following objectives:
• It must adequate to fund all current financial requirements;
• It must be liquid to meet current obligations as they fall due;
• It must be allocated properly and economically, to avoid losses arising from malversation or pilferage;
• It must be properly used for achievement of the firm’s profit goals.

Uses of working Capital are:
• Meeting net loss from sales
• Declaration of dividends
• Retiring of current liabilities above book value
• Purchasing fix assets
• Retiring capital debts and outstanding stocks
• Exchanging capital for current debts

Cash Flow
Is the continual movement of money throughout the enterprise during any period of time. A cash flow problem signifies therefore that the cash is not moving as required. In most cases, this means there is insufficient cash to meet the business needs.

The basic method in controlling cash is to determine its availability.

Accounts Receivables Management
Accounts receivables are money owned to a business from the sale, on credit, of goods or services in the normal course of business.

Trade Credit
Refers to credit sales made to other businesses, whereas

Consumer Credit
Refers to a credit sales made to individuals.

Benefits and Cost in granting credit:
• Increase in Profit and Sales
• Opportunity cost of investment (hold fund as account receivable rather than investing them on other form of profitable investment)
• Cost of bad debts and delinquent accounts.
• Cost of administration. (the process and collection)

Credit terminologies
Credit Period is the period between the date of purchase and the date when payment is due.
Discount Period is the number of days during which a discount for prompt payment is available to the buyer.
Discount Rate is an expression of price reduction a buyer will receive if payment is may within the discount period.

Short Run Operations – Financial Decisions

Three types of short term assets:
Cash and Short term investment
Accounts receivables

Long-run Operations-Financial Decisions
This introduces long run variables in financial management relating directly or indirectly to:
• Profits
• Liquidity
• Solvency
• Control

When managing long-run operations, capital expenditures are considered. This involve use of funds or commitment to use funds that would affect long run operations, these are outlays that are made for controlling long run prices, quality of product, fixed or variables costs and expenses. These are:

• Expenditure for price control
• Expenditure for sales expansion
• Expenditure for production control and expansion
• Expenditure for research and development
• Expenditure for general and administrative needs
• Strategic expenditures

Capital Budgeting is needed in order to plan and control capital expenditures. This provides a system for evaluating the firms alternatives, and choose the best that will give the company higher or better yield, if not the best.

Capital budgeting aims to:
• Set priorities
• Prepare cash plan
• Determine acquisition or construction plan
• Avoid duplication
• Modify plans

Capital budgeting system consists of the following steps:
• Budget requests preparation and submission
• Budget approval
• Budget appropriation
• Budget progress reports
• Budget post approval review

Break-even Point – Variable and fixed expenses
Breakeven point is the point where the difference between the sales income and the variable expenses equals the fix expense for the period.

Variable expenses are directly proportional to sales income.
• Materials and manufacturing labor cost
• Staff commissions based on sales made during the period

Fixed expenses remains constant whatever the sales activity maybe.


Selling price per unit = Php 10.00
Variable cost per unit = 6.00
Profit contribution per unit = 4.00

If fixed expense for the year is Php 720,000; the break even point is calculated as follows:

BEP = Php 720,000/Php 4.00 = 180,000 units

Therefore, sales value is Php 1,800,000 (180,000 units x Php 10.00)


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