1. Chapter 1 The Role of Working Capital
Sales
Inv
A /R
Cash

2. Objectives View firm as a system of cash flows
How Working Capital and depreciation create disparities between profit and cash flow
Management aspects of various Working Capital accounts

3. The Cash Flow Timeline Order Order Sale Payment Sent Cash
Placed Received Received
Accounts Collection
< Inventory > < Receivable > < Float >
Time ==>
Accounts Disbursement
< Payable > < Float >
Invoice Received Payment Sent Cash Disbursed

4. ...in the beginning Balance Sheet - June 1 Cash $1,000 Debt $ 500
Equity
Total $1, Total $1,000

5. The Next Day, June 2 The company purchases
Fixed Assets (for $600 cash)
And Inventory (for $300 on account)

6. The Next Day, June 2 Balance Sheet - June 2
Purchase Fixed Assets and Inventory
Cash $ A/P $ 300
Inventory Debt
Fixed Assets Equity
Total $1,300 Total $1,300

7. End of June The company Sells its inventory for $700 on account
Incurs unpaid operating expenses of $200
Paid interest and taxes worth $75
Accumulates $100 of depreciation on its fixed
Assets
Generates profits of $25

8. End of June Balance Sheet - June 30
Sale of product, incur operating expenses,
incur depreciation, and generate profit
Cash $ A/P $ 300
A/R Accruals
Inventory Debt
Fixed Assets Equity
(Accu. Dep.) (100) Retained Earnings
Total $1,525 Total $1,525

9. July 1 Balance Sheet - July 1 Pay operating accruals with cash
Cash $ A/P $ 300
A/R Accruals
Inventory Debt
Fixed Assets Common Stock
(Accum Depr) (100) Retained Earnings
Total $1,325 Total $1,325

10. July 15 Balance Sheet - July 15 Pay payables with cash
Cash $ ( 175) A/P $
A/R Accruals
Inventory Debt
Fixed Assets Common Stock
(Accum Depr) (100) Retained Earnings
Total $1,025 Total $1,025

11. July 31 Balance Sheet - July 31 Collect accounts receivable
Cash $ A/P $
A/R Accruals
Inventory Debt
Fixed Assets Common Stock
(Accum Depr) (100) Retained Earnings
Total $1,025 Total $1,025

12. Profit versus Cash Flow
Question: Why did the firm end up with $125 in additional cash while earning a profit of $25?
Answer: Some expenses are not cash expenses.
Question: Why did the firm run out of cash during its operating cycle?
Answer: The cash deficit was due to the differences between the timing of cash disbursements and cash receipts.

13. Important Points
Two basic aspects (objectives) of managing daily operations:
The firm must manage its cost structure so that operations are profitable.
WC accounts must be managed so that adequate liquidity is maintained.

14. Relationship Between Accrual Income and Cash Flow (page 9)
Income Statement Adjustment Account Cash Flow Account
Sales - Change in accounts receivable = Cash collected from customers
Cost of goods sold - Change in accounts payable
+ Change in inventory = Cash paid to suppliers
Operating expenses - Change in operating accruals
- Depreciation = Cash paid for
operating expenses
Interest - Change in accrued interest = Cash paid to creditors
Taxes - Change in accrued taxes
- Change in deferred taxes = Cash paid for taxes
_________________ ___________________
Net Profit Operating Cash Flow

15. Managing the Working Capital Cycle
The working capital cycle refers to the continual flow of resources through the various working capital accounts.
Expansion of the WC asset accounts absorb resources
Expansion of WC liability accounts provide resources.
Managing Inventory
Managing Receivables
Managing Payables

16. Managing Inventory Trade-offs between: Just-In-Time stock out costs
cost of excess inventory
ordering costs
Just-In-Time

17. Managing Receivables Character Capacity to Pay Collateral Condition
Who should receive credit and how much?
5 C’s of Credit
Character
Capacity to Pay
Collateral
Condition
Capital

18. Managing Receivables Credit terms: n/30 or 2/10, n/30
Monitoring the outstanding balance
Speeding up the receipt of payments
Reducing collection float
Collection float – delay in collecting payment on behalf of the seller
Disbursement float – delay in collecting payment on behalf of the supplier

19. Managing Payables Considered as interest-free-financing
Search for terms that match with cash receipts
Timing of payment
Controlled disbursement

20. Cash and Short-term Investments
Working Capital Cycle concludes with collection of cash
Liquid reserves
Distributions to shareholders
New investment
Amortization of debt
Rationale for liquid reserves include:
Funding daily operations
Buffering against adverse conditions
Attracting new shareholders by serving as a marketing tool
Funding strategic acquisitions

21. Is Working Capital Needed?
One view
Optimal level is zero
WC is an idle resource
Provides little or no value
How much in resources to commit?
- The optimal investment in working capital is debatable

22. Summary Firm must operate at a profitable level.
A profitable firm may still struggle financially.
Working capital soaks up cash flow and may cause an otherwise profitable firm to fail.
A successful firm’s operation is managed from a
Profit, and a
Cash flow perspective.

23. End-of-chapter questions
2, 4, 5, 6, 7, 10