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

Concept of working capital management
Evaluating techniques for working capital
Operating cycle and cash conversion cycle
Introduction
 Working capital management is the management of
the short-term investment and financing of a
company.
Definition:
 Basic metrics used to evaluate the company's
efficiency and its short-term financial health
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3
Formula
Working capital= current asset – current liabilities
WC = CA – CL
Goals
◦ Adequate cash flow for operations
◦ Most productive use of resources
Current Assets





Cash
Account receivable
Prepaid expense
Merchandise Inventory
Marketable securities
Current Liabilities


Accounts payable
Accrued expenses
Formula



Current Assets/Current Liabilities
Anything below 1 indicates negative W/C (working
capital).
While anything over 2 means that the company is
not investing excess assets.
Most believe that a ratio between 1.2 and 2.0 is
sufficient


Is used to measure the
efficiency of working
capital
The operating cycle is
the length of time it
takes
a
company’s
investment in inventory
to be collected in cash
from customers.
Collect on
Accounts
Receivable
Acquire
Inventory
for Cash
Sell Inventory
for Credit

The net operating cycle
(or the cash conversion
cycle) is the length of
time it takes for a
company’s investment
in
inventory
to
generate
cash,
considering that some
or all of the inventory
is purchased using
credit.
Pay
Suppliers
Acquire
Inventory
for Credit
Collect on
Accounts
Receivable
Sell
Inventory
for Credit
Copyright © 2013 CFA Institute
8

Formula
1. Days Inventory outstanding (DIO): is the
average number of days a company hold their
inventory before sell
 Formula:
DIO= 365/ inventory turnover*
*inventory turnover= COGS/average inventory**
**Avg. inventory= (beg.+ ending inventory)/2
2. Day sales outstanding (DSO): is the average
number of days a company takes to collect
revenue after sales has been made.
 Formula:
DSO= 365/ Account receivable turnover*
*A/R turnover= Sales/average A/R **
**Avg. A/R= (beg.+ ending A/R)/2
3. Days payable outstanding (DPO): is the average
number of days a company takes to pay its
suppliers.
 Formula:
DPO= 365/ Account payable turnover*
*A/P turnover= COGS/average A/P **
**Avg. A/P= (beg.+ ending A/P)/2
Case:
Item
1/31/2004
1/31/2003
Revenue
6000
COGS
7000
Inventory
1000
2000
A/R
500
400
A/P
800
900
Average inventory
(1000+2000)/2 = 1500
Average A/R
(400+500)/2= 450
Average A/P
(800+900)/2 = 850
DIO = $1,500 / ($7,000/ 365) = 78.2 days
DSO = $450 / ($6,000 / 365 days) = 27.3days
DPO = $850 / ($7,000/ 365) = 44.3 days
CCC = 78.2+27.3- 44.3= 61.26 days
Items
Kohler’s company
X company
DIO
85 days
78 days
DSO
38 days
27 days
DPO
31 days
44 days
CCC
92 days
61 days