NIPA, JOAN L.

BSA V-B
WORKING CAPITAL MANAGEMENT-CONCEPTS
1. Working capital refers to the difference between current assets and
current liabilities. It has significant effect on the ability of the company to
meet maturing obligations and carry on profitable operations.
2. Cash is the lifeblood of business and how it's managed can mean the
difference between your company's success or failure. Having ample cash on
hand will ensure that your suppliers, employees and other vendors can be
paid on time. It also allows companies to invest cash back into the business
in order to generate additional revenue and profit and, most importantly,
improve their bottom line.
3. Cash is king means that when measuring wealth or value we use cash flow
not accounting income as measurement tool.
4.

(a) Profitability is the ability of the business to earn profit.

(b) Liquidity is the availability of cash in the near future to cover
currently maturing obligations
(c) Solvency is the availability of cash over the long term to meet
financial commitments when they fall due.
5. Optimal transaction size of cash is Optimal balance here means a position
when the cash balance amount is on the most ideal proportion so that the
company has the ability to invest the excess cash for a return [profit] and at
the same time have sufficient liquidity for future needs.
6. The opportunity cost of holding money is the cost that could be realized if
money were invested instead of held. In other words, it is the interest rate
that money is earning in a chosen investment. Typically, it is the interest rate
that is set on a bond, particularly a government bond. Given the other
investment choices that could be made, this cost could be very different
from one person or entity to another. To determine the true opportunity cost
of holding money, it is necessary to first determine what the investment
vehicle would have been. After that, the next step is to research what the
interest rate would be on that investment strategy. If the annual percentage
rate is a single percent, then one percent annually would be the opportunity
cost of holding onto the money. Assigning a definite value would require first
knowing how much money was being held, and how long it would be held for.
In economics, investing and holding money are known as mutually exclusive
choices. This means that both cannot be done at the same time with the
same money. If the money is being invested, it cannot be held. It may be

possible for an individual to change his or her mind concerning the best
choice for that money, but both strategies are not done simultaneously.
There is a cost associated with holding money balances (you give up interest
payments),
7. Float means delay or the delay between when funds are sent by a payer to
a payee.
8. Collection float is the time between when a payer sends payment and the
funds are credited to the payees bank account.
Disbursement float is the time between when a payer sends payment and
when the funds are deducted from the payers account.
9. Stretching of payables is the slowing down of payments through controlled
disbursing and other methods.
10. Cash is a better metric of a company's financial health for two main
reasons. First, cash flow is harder to manipulate under GAAP than net income
(although it can be done to a certain degree). Second, "cash is king" and a
company that does not generate cash over the long term is on its deathbed.
11. Receivable turnover is an efficiency ratio or activity ratio that measures
how many times a business can turn its accounts receivable into cash during
a period. In other words, the accounts receivable turnover ratio measures
how many times a business can collect its average accounts receivable
during the year.
Formula: Net Credit Sales Average Accounts Receivable
12. The average collection period is the average number of days between 1)
the date that a credit sale is made, and 2) the date that the money is
received from the customer. The average collection period is also referred to
as the days' sales in accounts receivable.
Formula: 365 days Accounts Receivable Turnover Ratio
13. Average collection period is basic test of the businesss good or bad
activity or operation. The degree to which this is useful for a business
depends on the businesss relative reliance on credit sales or credit policy of
the entity. The average collection period should be compared with the firm's
credit policy to see how well the firm is doing. If the average collection
period, for example, is 45 days, but the firm's credit policy is to collect its
receivables in 30 days, then the entity is not effective in managing its credit
transactions.

14. (a) Tightening credit standards lowers accounts receivable and bad
debts but also lowers sales and profits.
(b) Relaxing credit standards generally increases sales and bad debt
expense.
15. Average accounts receivable may be calculated by simply dividing the
sum of beginning and ending balance of A/R by 2.
16. Inventory turnover is a measure of the number of times inventory is sold
or used in a time period such as a year.
Formula: Cost of Goods Sold Average Inventory
17. Days sales outstanding (DSO) is the average number of days that
receivables remain outstanding before they are collected.
Formula: ( Accounts Receivable Annual Revenue ) Number of daysthe year
18. Days sales outstanding (DSO) is important because the speed at which a
company collects cash is important to its efficiency and overall profitability.
The faster a company collects cash, the faster it can reinvest that cash to
make more sales. Meanwhile, shelf-life is the length of time a food can be
kept under stated storage conditions while maintaining its optimum safety
and quality. DOS should be shorter than a products shelf life in order to
efficiently manage inventory of the entity.
19. Economic order quantity (EOQ) is the order quantity that minimizes the
total inventory holding costs and ordering costs.

Formula:

20.

1. Ordering costs
Formula: No. of orders= Annual demand/ EOQ or order size
Total ordering costs= No. of orders X Ordering costs per order
2. Carrying costs
Formula: Average Inventory= EOQ or order size/ 2

= (EOQ or order size/2) + safety stock

Total Carrying Costs= Average Inventory (w/o safety stock) X
Carrying cost per unit
Safety stock costs= Safety stock X Carrying cost per unit

21. Stockout is a situation in which the demand or requirement for an item

cannot be fulfilled from the current inventory.
22. CS = (NDOS x AUSPD x PPU) + CC
Where:
CS = Cost of a Stockout
NDOS = Number of Days Out of Stock
AUSPD = Average Units Sold Per Day
PPU = Price Per Unit (some use Profit Per Unit)
CC = Cost of Consequences
23. Safety stock is a buffer supply of inventory that minimizes the
possibility of running out of a product or component.
Lead time refers to the time in days it takes from the placement of an
order to when the goods arrive or are produced.
Reorder point refers to the inventory level where a purchase order
should be placed.
24. Often linked to administrative burdens measurements, irritation costs are
a residual category of direct cost, which is more difficult to quantify or
monetize, and also difficult to relate to a specific information obligation.
These are more subjectively felt costs that are related to the overlapping of
regulatory requirements on specific entities, be they citizens or businesses.
By definition, these costs are important for subjective well-being, but very
difficult to quantify or monetize. These costs can include costs related to
administrative delays (when not directly attributable to an information
obligation) and relatedly, the opportunity cost of waiting time when dealing
with administrative or litigation procedures. At the same time, irritation
burdens are often accounted for in the measurement of administrative
burdens (although they are normally not quantified) whenever they are
related to specific information obligations, and especially in case of overlaps,
redundancies or even worse inconsistencies between legislative provisions.
Irritation Costs the cost associated with being unable to draw on a stock of

raw material thus causing the customers to be irritated. Goofs damaged in

transit or while in transit or while stored in warehouse can result in
nonsalable merchandise or damaged merchandise that can also cause
negative customer reaction. Costs associated with the customers switching
to a competitive product.
25.
Traditional Models
EOQ Model
The EOQ model assumes that demand is constant, and that inventory
is depleted at a fixed rate until it reaches zero.
Reorder Point Model
Establishes the level of inventory on hand when order is made.

Order Cycling Method

Establishes schedules of periodic or regular view of quantities of
inventories on hand to determine the number of unite to be ordered and
bring the stock balance at a desire level.
Min-Max Method
Sets the definable limits in inventory balances. The minimum inventory
level serves as the reorder point. In includes the normal quantity to be used
from the time an order is placed up to the time the materials are received.
The safety stock quantity to minimize the occurrence of stockout is also
included. The maximum inventory level is the sum of stockout quantity and
the order size.
Two-Bin System
Is one of the practical application of min-max method. Materials are
stored in bins, piles, bundles or specific stocking area. Two bins are used: one
bin contains the quantities to be used from the date the materials are
received up to the time an order is to be placed, and the other bin contains
the quantities to be used during the waiting time (lead time) and the safety
stock. Once the first bin is consumed, an order for two bins is automatically
placed.
ABC Model (Selective Control Model)
Classifies inventories into three classes, A, B and C; A for high value,
critical items; B for the middle value items; and class C as the low value
items. The ABC model is related to Paretos law or the 80-20 rule.

Modern Inventory Management

JUST-IN-TIME (JIT).
Just-in-time (JIT) is a philosophy that advocates the lowest possible
levels of inventory. JIT espouses that firms need only keep inventory in the
right quantity at the right time with the right quality. The ideal lot size for JIT
is one, even though one hears the term "zero inventory" used.
Flexible Manufacturing System (FMS)
A flexible manufacturing system (FMS) is a manufacturing system in
which there is some amount of flexibility that allows the system to react in
case of changes, whether predicted or unpredicted. This flexibility is
generally considered to fall into two categories, which both contain
numerous subcategories.
Computer-Integrated Manufacturing (CIM)
Computer-integrated manufacturing (CIM) is the manufacturing
approach of using computers to control the entire production process. This
integration allows individual processes to exchange information with each
other and initiate actions. Through the integration of computers,
manufacturing can be faster and less error-prone, although the main
advantage is the ability to create automated manufacturing processes. CMI
model adhere to the JIT inventory principles. CMI allows the customer to
order and control their inventory from their vendors/suppliers.
Material requirements planning (MRP)
Material requirements planning (MRP) is a computer-based inventory
management system designed to assist production managers in scheduling
and placing orders for items of dependent demand. Dependent demand
items are components of finished goodssuch as raw materials, component
parts, and subassembliesfor which the amount of inventory needed
depends on the level of production of the final product.
Advantages: Helping production managers to minimize inventory levels
and the associated carrying costs, track material requirements, determine
the most economical lot sizes for orders, compute quantities needed as
safety stock, allocate production time among various products, and plan for
future capacity needs.
Disadvantages: Relies upon accurate input information, can be difficult,
time consuming, and costly to implement.
MRP II
It represents an effort to expand the scope of production resource
planning and to involve other functional areas of the firm in the planning
process," such as marketing, finance, engineering, purchasing, and human

resources. MRP II differs from MRP in that all of these functional areas have
input into the master production schedule. From that point, MRP is used to
generate material requirements and help production managers plan capacity.
MRP II systems often include simulation capabilities so managers can
evaluate various options
Enterprise resource planning (ERP)
Enterprise resource planning (ERP) is a method of using computer
technology to link various functionssuch as accounting, inventory control,
and human resourcesacross an entire company. ERP is intended to
facilitate information sharing, business planning, and decision making on an
enterprise-wide basis.