CHAPTER 1

INTRODUCTION OF
WORKING CAPITAL
MANAGEMENT

CHAPTER OBJECTIVES
In this chapter, students learn:
- Difference the working capital and net
working capital
- Interpretation of net working capital and
FNOs
- Define the working capital management.
- Briefly introduce the working capital
investment and financing
- Understand the influence of working
capital management on cash cycle,
liquidity and companys valuation

1. DEFINITION OF WORKING
CAPITAL AND NET WORKING
CAPITAL
Current
assets
Cash
Inventory
receivables

Non- current
assets

Short-term
operating
liabilities
Payables
Accrual: Wages, Tax
Short-term debt

Long-term capital

1. DEFINITION OF WORKING
CAPITAL AND NET WORKING
CAPITAL
There

are two major concepts of working

capital net working capital and gross
working capital (called working capital)
From the financial analyst view, working
capital is involved in current assets
when accountants use the term working
capital, they are generally referring to net
working capital, which is the dollar
difference between current assets and
current liabilities.

1. DEFINITION OF WORKING
CAPITAL AND NET WORKING
CAPITAL
Short-term
Workin
g
capital

operating
liabilities
Payables
Accrual: Wages,
Tax

Current assets
Cash
Inventory
receivables

Short-term debt
Net
Working
capital

Non- current
assets

Long-term
capital

1. DEFINITION OF WORKING CAPITAL

AND NET WORKING CAPITAL
Working

capital is shown as the

current assets
Net working capital is the difference
between current assets and current
liabilities.
Net working Capital = Current Assets
Current Liabilities.

NET WORKING CAPITAL

Net Working capital = Current Asset
Current Liabilities
= Total Assets Fixed assets (Total
Liabilities & Equity Long-term capital)
Net working capital = Long-term
Capital Fixed assets
Net working capital is the amount of
long term capital that is devoted to
financing the current asset of the firm.

1. DEFINITION OF WORKING
CAPITAL AND NET WORKING
CAPITAL
Short-term
operating
liabilities
Payables
Accrual: Wages, Tax

Current assets
Cash
Inventory
receivables

Short-term debt

FNOs
Non- current
assets

Long-term capital

FNOs
Financial Needs for Operation (FNOs) =
Current Assets Short-term Operating
Liabilities
The remaining financial capital needed to
sustain the operation of the firm after taking
into account its short-term operating
liabilities, is referred to as its financial
need for operation (FNOs).
FNOs is crucial sources of financing
needed to run the business.

2. WORKING CAPITAL
MANAGEMENT
Working capital management
considers the administration of the firms
current assets namely, cash and
marketable securities, receivables, and
inventory and the financing (especially
short-term financing) needed to support
current assets (Van Hough, Fundamental
of Financial management, thirteenth
edition)

Working capital
investment decisions

Working capital
financing decisions

- How much working

capital enough?
- How to manage
working capital
accounts: cash,
inventory, account
receivables

- How much
different source of
financing used?
- Which kinds of
source of financing
should use?

WORKING CAPITAL
INVESTMENT
The

working capital investment policies

shows how much working capital
account should invest in current assets.
The number of alternative investment is
depend on slightly different risk-return
dimensions that presents a major
challenge to investment manager.

WORKING CAPITAL
INVESTMENT POLICY
Definition

Advantages

Disadvantag
e

Relax current
asset policy

Large
Dont miss
proportion
storage
current assets
relative to
sales

Restricted
current asset
policy

Small
Increase
Storage
proportion
return of
Unhappy
current assets current assets customer
relative to
sales

Moderate
current asset
policy

Reduce return
of current
assets

WORKING CAPITAL
FINANCING
Two

sources of financing: short-term

operating liabilities and FNOs
FNOs = Current assets short-term
operating liabilities
The level of FNOs is depend on the
internal factors (the dynamics of
working capital management) and
external effects (competitive position
and other environments).

LEVEL OF WORKING
CAPITAL

Low level of working capital: relying

mostly on short-term debt and issuing longterm capital only when required, might
capture some extra profitability but riskier
especially in the case of economic crisis or
inefficient market
High level of working capital: firm has
excess long-term financing (either long-term
debt or equity). This firm is likely paying a
high cost of capital for its financing leading to
decreasing profit but safer and flexible

3. THE ROLES OF WORKING

CAPITAL MANAGEMENT

The cash cycle referred to the long lag time

between the date that cash is received and the
date that cash is paid.

WORKING CAPITAL
MANAGEMENT AND CASH CYCLE
The cash cycle refers to the continual flow
of resource through various working
capital accounts such as cash, account
receivables, inventory, payables and
accruals that working capital
management focus

WORKING CAPITAL
MANAGEMENT AND LIQUIDITY
Working

capital management influences

on the cash flows of company. The
efficient working capital management
can lead to the sufficient cash flow for
company that can meet the current
obligation on its due date and prevent
financial distress.

Inventory
Level, Mix
Cash conversion
period

Timing
Customer integration
Corporate
strategy

Competitive
and Market
Environmen
ts

Supply
Receivables:
integration
Quantity
IS integration
Quality

Collection

chain

Cash Management:
Timing
Cash position
Customer
integration
Amount
and timing
IS
integration
of:
collection,
disbursement
and
Payables
concentration
Utilization
Banking system
Timing
IS integration
Supplier negotiation
Source of financing
Purchasing
Yield
integration
Maturities
IS integration
Liquidity

Operating cash flow

Risk posture
Interest- profit
Quality and
Timelines of
Information

Value
Creation