FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Lesson
title:
WORKING
CAPITAL
AND
CASH
MANAGEMENT
Lesson Objectives:
At the end of this module, I should be able to:
1. explain how different amounts of current assets and
current liabilities affect firm’s profitability and thus their
stock prices
2. explain how companies decide on the proper amount of
each current asset – cash, marketable securities,
accounts receivable and inventory
Class number: ____
Date: ___________
Materials:
SAS
References:
Brigham, E. and Houston, J.
(2013).
Fundamentals
of
Financial Management. Pasig
City: Cengage Learning Asia
Pte. Ltd.
Productivity Tip: To help you grasp most of the topic today, condition your mind before starting. Relax
and be excited for the new learning you will have. It also helps that you put yourself in the shoes of the
firm’s management to better understand the importance of working capital and cash management.
A. LESSON PREVIEW/REVIEW
1) Introduction
In this module and the next 2 modules, we will learn about the concept of working capital, its
components, effect on a firm’s profitability, credit policies companies set, the determination of
the cost of trade credit, bank loans and commercial paper, and the ways a company uses
security to lower their costs of short-term credit. Furthermore, we will discuss the cash
conversion cycle.
2) Activity 1: What I Know Chart, part 1 (3 mins)
Do you know anything about working capital management? Try answering the questions below
by writing your ideas under the first column What I Know. It’s okay if you write key words or
phrases that you think are related to the questions.
What I Know
Questions:
What I Learned (Activity 4)
What is working capital and net
working capital?
This document is the property of PHINMA EDUCATION
Page 7 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
What are the current assets
investment policies and current
assets financing policies?
B. MAIN LESSON
1) Activity 2: Content Notes
WORKING CAPITAL
The working capital of a company is its current assets. Working capital comprises assets that are
used in the company’s normal operations and then replaced all during the year. Any current assets
not used in normal operations, such as excess cash held to pay for a plant under construction, are
deducted and thus not included in working capital. Working capital typically includes cash,
receivables and inventories.
NET WORKING CAPITAL
Net working capital is the difference we get from subtracting the sum of payables and accruals from
the working capital. It represents the amount of money the company must obtain from non-free
sources to carry its non-current assets. When a company buys inventory from its suppliers on credit,
its suppliers effectively lend it the money used to finance the inventory. These loans are recorded as
payables, and they are typically “free” in the sense that they do not bear interest, contrary to loans
obtained from the bank. In the same way, a company pays its workers wages every two weeks and
its taxes on a monthly or quarterly basis, so its labor force and tax authorities effectively provide it
with loans recorded as accruals. The total amount of interest-free loans is deducted from working
capital to obtain the net working capital.
CURRENT ASSETS INVESTMENT POLICIES
This document is the property of PHINMA EDUCATION
Page 8 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
Figure 1. Current Assets Investment Policies
Source: Brigham, E. and Houston, J. (2013). Fundamentals of Financial Management. Pasig
City: Cengage Learning Asia Pte. Ltd.
1. Relaxed Current Asset Investment Policy
- Relatively large amounts of cash, marketable securities, and inventories are carried; and a
liberal credit policy results in a high level of receivables.
2. Restricted Current Asset Investment Policy
- Holdings of cash, marketable securities, inventories, and receivables are constrained.
- means a low level of assets (hence, a high total assets turnover ratio), which results in a high
ROE, other things held constant.
- Note: We can use the DuPont equation to demonstrate how working capital management
affects ROE:
𝑅𝑂𝐸 =
𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑆𝑎𝑙𝑒𝑠
𝑆𝑎𝑙𝑒𝑠
𝐴𝑠𝑠𝑒𝑡𝑠
𝑥 𝐴𝑠𝑠𝑒𝑡𝑠 𝑥 𝐸𝑞𝑢𝑖𝑡𝑦
3. Moderate Current Asset Investment Policy
- Between the relaxed and restricted policies.
This document is the property of PHINMA EDUCATION
Page 9 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
CURRENT ASSETS FINANCING POLICIES
Current assets financing policy is the way current assets are financed. Current assets may be
permanent or temporary. Permanent current assets are those that a company maintains even at the
low point of the business cycle. Temporary current assets are those that fluctuate with seasonal or
cyclical variations in sales.
1. Moderate Approach (Maturity Matching or Self-Liquidating Approach)
- calls for matching asset and liability maturities
Figure 2.1 Moderate Approach
2. Aggressive Approach
- finances some of its permanent assets with short-term debt.
This document is the property of PHINMA EDUCATION
Page 10 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
Figure 2.2 Relatively Aggressive Approach
3. Conservative Approach
- long-term capital is used to finance all the permanent assets and to meet some of the
seasonal needs
Figure 2.3 Conservative Approach
Source: Brigham, E. and Houston, J. (2013). Fundamentals of Financial Management. Pasig
City: Cengage Learning Asia Pte. Ltd.
2) Activity 3: Skill-building Activities
This document is the property of PHINMA EDUCATION
Page 11 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
Let’s practice! After completing each exercise, you may refer to the Key to Corrections for
feedback. Try to complete each exercise before looking at the feedback.
Exercise 1: Write down the basic formula to get (a) working capital and (b) net working capital
based on your readings.
a. ______________________________________________________________________
b. ______________________________________________________________________
Exercise 2: Write T if the statement is true. Otherwise, underline the term/word that make sthe
statement incorrect and write the correct term/word in the blank.
__________________1. Net working capital is the difference between the firm’s current asset
and current liabilities. It is used as a measure to check the solvency of the firm.
__________________2. Working capital management is concerned with the efficient and
effective utilization of working capital to attain the predetermined objectives of the company
relative to profitability of operation, liquidity of financial resources, and minimization of risks and
company costs.
_________________3. The goal of management is to maintain a cash level at a maximum
without putting the company at risk.
__________________4. Working capital policies is concerned with the level and financing of
each component of the current liabilities.
__________________5. The conservative policy has the highest risk and highest return.
__________________6. By managing cash, receivables, inventory, and account payable, a firm
can maximize its rate of return and maximize its liquidity and business risk.
__________________7. Financial ratios play a crucial role in managing working capital. It
draws important information that the firm may use in order to improve its working capital.
__________________8. Policies serve as a guideline in executing the transactions and
activities of the company. However, if the existing policy does contribute to the general welfare
of the firm, changing it would be a better option.
__________________9. Internal control has an important part in securing the working capital of
the firm.
_________________10. Matching policy works in arrangement where the current assets of the
business are used to perfectly match the noncurrent assets.
3) Activity 4: What I Know Chart, part 2
It’s time to answer the questions in the What I Know chart in Activity 1. Log in your answers in
the table.
4) Activity 5: Check for Understanding (5 mins)
Choose and write the letter of your answer on the box beside the question.
This document is the property of PHINMA EDUCATION
Page 12 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
1. Firms generally choose to finance temporary assets with short-term debt because
a. Matching the maturities of assets and liabilities reduces risk.
b. Short-term interest rates have traditionally been more stable than long-term
interest rates.
c. A firm that borrows heavily long-term is more apt to be unable to repay the debt
than a firm that borrows heavily short-term.
d. The yield curve has traditionally been downward sloping.
e. Sales remain constant over the year, and financing requirements also remain
constant.
2. Which of the following statements is most correct?
a. Permanent current assets are those current assets that must be increased
when sales increase during an upswing.
b. Temporary current assets are those current assets on hand at the low point of
the business cycle.
c. Maturity matching is considered an aggressive financing policy.
d. An aggressive current asset financing policy uses a minimum amount of
short-term debt.
e. None of the statements above is correct.
3. Which of the following statements is most correct?
a. Net working capital may be defined as current assets minus current liabilities.
Any increase in the current ratio will automatically lead to an increase in net
working capital.
b. Although short-term interest rates have historically averaged less than long-term
rates, the heavy use of short-term debt is considered to be an aggressive
strategy because of the inherent risks of using short-term financing.
c. If a company follows a policy of “matching maturities,” this means that it
matches its use of common stock with its use of long-term debt as opposed to
short-term debt.
d. All of the statements above are correct.
e. None of the statements above is correct.
This document is the property of PHINMA EDUCATION
Page 13 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
4. Wildthing Amusement Company’s total assets fluctuate between $320,000 and
$410,000, while its fixed assets remain constant at $260,000. If the firm follows a
maturity matching or moderate working capital financing policy, what is the likely level
of its long-term financing?
a. $ 90,000
b. $260,000
c. $350,000
d. $410,000
e. $320,000
5. Which of the following statements is most correct?
a. Accrued liabilities are an expensive way to finance working capital.
b. A conservative financing policy is one in which the firm finances all of its fixed
assets with long-term capital and part of its permanent current assets with
short-term, nonspontaneous credit.
c. If a company receives trade credit under the terms 2/10 net 30, this implies the
company has 10 days of free trade credit.
d. Statements a and b are correct.
e. None of the answers above is correct.
C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning
Congratulations for finishing this module! Shade the number of the module that you finished.
Did you have challenges learning the concepts in this module? If none, which parts of the module
helped you learn the concepts?
__________________________________________________________________________________
___________________________
This document is the property of PHINMA EDUCATION
Page 14 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Class number: ____
Date: ___________
Some question/s I want to ask my teacher about this module is/are:
__________________________________________________________________________________
_________________________________________________________________
FAQs
1. What are some pros and cons of holding high levels of current assets in relation to sales using
the DuPont equation?
⮚ The DuPont equation is: ROE = Profit margin on sales x Total assets turnover x
Leverage factor. A relaxed current assets investment policy means that relatively large
amounts of cash, marketable securities, and inventories are carried, and a liberal credit
policy results in a high level of receivables. This policy minimizes operating problems,
thus the impact on sales is minimized; however, it results in a low assets turnover
because assets are increased. Therefore, ROE is reduced.
Homework:
Read Chapter 17, Working Capital Management, in Essentials of Financial Management by Eugen
Brigham, et al. Pages 615-630.
KEY TO CORRECTIONS
Answers to Skill-Building Exercises
Exercise 1:
a. Working Capital = Current assets
b. Net working capital = Current assets – (Payables + Accruals)
Exercise 2:
1. solvency - liquidity
2. T
3. maximum - minimum
4. liabilities - assets
5. conservative - aggressive
6. maximize its liquidity – minimize its liquidity
7. T
8. does contribute – does not contribute
9. T
10. non-current assets – current liabilities
This document is the property of PHINMA EDUCATION
Page 15 | 10
FIN 081: Financial Management
Student Activity Sheet Module #10
Name: _________________________________________________________
Section: ____________ Schedule: __________________________________
Answers to Checking for Understanding:
1. A
2. E
3. B
4. E
Class number: ____
Date: ___________
5. C
This document is the property of PHINMA EDUCATION
Page 16 | 10