WORKING CAPITAL MANAGEMENT (WCM) involves managing the firm’s current assets and current liabilities in order to
term ‘working capital’ generally refers to
current assets only. For purposes of WCM, ‘working capital’ refers to the difference between current assets and current
liabilities (i.e., net working capital): ✓ The minimum working capital requirement regardless of the seasonal variations in
business operations is called PERMANENT (fixed) working capital. ✓ When additional working capital is needed during
the more active business season, such working capital is called SEASONAL (variable or incremental) working capital.
WORKING CAPITAL FINANCING refers to optimal level, mix and use of current assets and current liabilities. Consider the
following working capital financing policies: 1) CONSERVATIVE financing strategy a.k.a. relaxed policy: a company seeks
to minimize liquidity risk by maintaining a relatively high level of working capital. This policy reduces liquidity risk but is
considered less profitable due to more reliance on long-term financing, which incurs relatively higher financing costs. 2)
AGGRESSIVE financing strategy a.k.a. restricted policy: operations are conducted with a minimum amount of working
capital. This policy enhances profitability by relying more on short-term debts rather than long-term debts but is
considered risky due to higher chances of short-term insolvency. 3) MODERATE financing strategy a.k.a. balanced or
semi-aggressive or semi-conservative policy: working capital maintained is relatively not too high (conservative) nor too
low (aggressive). 4) MATCHING financing strategy a.k.a. self-liquidating or hedging policy: this policy is achieved by
matching the maturity of financing source with an asset’s useful life -- short-term assets are financed with short-term
liabilities; long-term assets are funded by long-term financing sourc
structural component of working capital. A sound practice of WCM would normally involve the following: ✓ Managing
cash and its temporary investment efficiently. (Cash & Marketable Securities Management) ✓ Drafting and
implementing effective credit and collection policies. (Receivable Management) ✓ Seeking favorable terms from
suppliers and other short-term creditors. (Short-Term Credit Financing) ✓ Ensuring efficient manufacturing operations
and sound
reasons for holding cash: “Why would a firm hold cash when, being idle, it is a non-earning asset?” 1) TRANSACTION
motive (Liquidity motive): cash is held to facilitate normal transactions of the business. 2) PRECAUTIONARY motive
(Contingent motive): cash is held beyond the normal operating requirement to provide for buffer against contingencies,
such as slow-down in collection and possibilities of strikes. 3) SPECULATIVE motive: cash is held to avail of profit-making
opportunities (e.g., sudden price drop). 4) CONTRACTUAL motive: cash is held as required by contracts or covenants
uantity or Economic Conversion
Size, is based on the following formula under the BAUMOL model