Working Capital

Calculating the Targeted CCC
• Account Receivable is a balance due from a
• Credit Policy is a set of rules that include the
firm’s credit period, discounts, credit standards,
and collection procedures offered
• Credit Period is the length of time customers
have to pay for purchases
• Discounts is a price reductions given for early
Calculation of Write-Offs
How to calculate Credit Sale
Current Assets
When most of us use the term cash, we mean
currency (paper money and coins)
in addition to bank demand deposits.
However, when corporate treasurers use the term, they often mean
currency and demand deposits in addition to very safe, highly liquid
marketable securities that can be sold quickly at a predictable price
and thus be converted to bank deposits. Therefore, “cash” as
reported on balance sheets generally includes short-term securities,
which are also called “cash equivalents.
Marketable Securities
• Note that a firm’s marketable security holdings
can be divided into two categories: (1) Operating
short-term securities, which are held primarily to
provide liquidity and are bought and sold as
needed to provide funds for operations, and (2)
other short-term securities, which are holdings in
excess of the amount needed to support normal
operations. Highly profitable firms such as
Microsoft often hold far more securities than are
needed for liquidity purposes.
• Inventories, which can include (1) supplies, (2)
raw materials, (3) work in process, and (4)
finished goods, are an essential part of
virtually all business operations. Optimal
inventory levels depend on sales, so salesmust
be forecasted before target inventories can be
• Account Receivable; Funds due from a
• Although some sales are made for cash, today
the vast majority of sales are on credit. Thus,
in the typical situation, goods are shipped,
inventories are reduced, and an account
receivable is created
Credit Terms
• Firms generally publish their credit terms,
defined as a statement of their credit period
and discounts policy. Thus, Allied Foods might
have stated credit terms of 2/10, net 30,
which means that a 2 percent discount is
allowed if payment is received within 10 days
of the purchase, and if the discount is not
taken then the full amount is due in 30 days.
• Firms generally make purchases from other firms on credit and record the
debt as an account payable. Accounts payable, or trade credit, is the
largest single category of short-term debt, representing about 40% of the
average corporation’s current liabilities. This credit is a spontaneous
source of financing in the sense that it arises spontaneously from ordinary
business transactions. For example, if a firm makes a purchase of $1,000
on terms of net 30, it must pay for goods 30 days after the invoice date.
This instantly and spontaneously provides $1,000 of credit for 30 days. If
the firm purchases $1,000 of goods each day, on average, it will be
receiving 30 times $1,000, or $30,000, of credit from its suppliers. If sales,
and consequently purchases, double, its accounts payable also will double,
to $60,000. So simply by growing, the firm spontaneously generates
another $30,000 of financing. Similarly, if the terms under which it buys
are extended from 30 to 40 days, its accounts payable will expand from
$30,000 to $40,000. Thus, expanding sales and lengthening the credit
period generate additional financing.
Monitoring Accounts Receivable
• The total amount of accounts receivable
outstanding at any given time is determined by
the volume of credit sales and the average
length of time between sales and collections.
For example, suppose Boston Lumber Company (BLC),
a wholesale distributor of lumber products, has credit
sales of $1,000 per day, requires payment after 10
days, and has no bad debts or slow-paying customers.
Under these conditions, it must have the capital to
carry $10,000 of receivables: