Bwff3103 - PP Chapter 8 A231

CHAPTER 8
WORKING CAPITAL MANAGEMENT IN SMALL

BUSINESS
By:
Hisham bin Mohammad
SEFB, UUM
CHAPTER OUTLINE
Cash management and

money market securities
Management of inventory
Management of accounts
receivable
CASH MANAGEMENT AND MONEY MARKET
SECURITIES
Working Capital
The firm’s total investment in current assets or assets that it
expects to be converted into cash within a year or less.
In other words, working capital is a business’s investment in

current assets comprising CASH, DEBTORS and INVENTORIES.
This investment is needed in order to allow an entrepreneur

to begin his/her business activities and sustain the business
operation in the long run.
Usually, business working capital is not fully belongs to the
entrepreneur
Some of the working capital elements (e.g. inventories) may

still under finance (payables) at the time the entrepreneur
starting his/her business activities
Net Working Capital (NWC)

The difference between the firm’s current assets and its
current liabilities. Frequently when the term working capital is
used, it’s actually intended to mean net working capital
Working capital is a measure of a company’s operational

efficiency and short-term financial health
Class discussion:
What do you need to have prior starting a business?
MANAGEMENT OF CASH
Cash is needed among other working capital elements in

order to allow business to run smoothly
Cash is needed for the purpose of returning balance to

customers especially when payment is being made using high
denomination banknotes
Without enough cash in hand, business transactions may not

running smoothly and could be having difficulties which may
eventually reflect business’s sales and profits.
However, total cash that need to be maintained in hand could
be vary between businesses depending on their size and scale
which are likely to be different between each other
For instance, total amount of cash that need to be maintained

by a grocery store is likely to be different than a mini market
And even though we have allocated enough cash for daily

rolling in our business (which we thought to be sufficient),
deficit and surplus may still occur
In the event of deficit, short-term borrowing could be one of
the solutions available to overcome the problem
However, in the event of surplus, the extra available cash

should be wisely channeled by entrepreneurs to the right
platform(s) to prevent the loss of value on the available cash
resulting from the time value of money effect
For example, entrepreneurs should think of investing any

extra available cash into marketable securities or any high
liquidity short-term investment for the sake of earning some
returns
These short-term investment instruments could be turned to
cash within short time period should the business needs cash
Maintaining too much idle cash in business may not be a good

option as the amount of cash will remain the same whilst the
value will keep depreciates from time to time due to the time
value of money effect
MANAGEMENT OF INVENTORY
Inventory is one of the working capital elements
It usually refers to goods, trade merchandise and anything
bought to be sold to our customers for the purpose of getting
profits
Three types of inventory:

Raw material inventory
Work in process inventory
Finished goods inventory
INVENTORY MANAGEMENT
It is a practice of tracking and controlling the inventory orders, its
usage and storage along with the management of finished goods
that are ready for sale.
 Material requirement planning (MRP)

 Just in time (JIT)
 ABC analysis
 Economic order quantity (EOQ) model*
 Minimum safety stocks (buffer stocks)
 LIFO and FIFO
ECONOMIC ORDER QUANTITY MODEL (EOQ)
It focuses on taking a decision regarding how much quantity of

inventory should the company order at any point of time and
when should they place the order.
In this model, the store manager will reorder the inventory when it
reaches the minimum level.
EOQ model helps to save the ordering cost and carrying costs
incurred while placing the order.
With the EOQ model, the organization is able to place the right
quantity of inventory.
Example:
Aura Wind Auto Parts (AWAP) is trying to determine the optimal
order quantity for a Brembo brake caliper set. It is expected to
sell approximately 200 sets of the brake caliper in the next year
at a price of RM599.90 per set. AWAP has the following
information:
 The delivery time is 20 days (Assume a 360 days a year in

your calculation)
 The ordering cost is RM12 per order
 The desired safety stock is 30 sets
 The carrying cost is 10% of the purchase price
 Orders must be placed in round lots of 40 sets
 The purchase price is RM359 per set
Based on the information given,
1. determine the optimal Economic Order Quantity (EOQ) level
2. how many orders will be placed annually?
3. what is the average inventory level?
4. calculate the total inventory costs
5. what is the inventory order point?

MANAGEMENT OF ACCOUNTS RECEIVABLE
• Accounts receivable exist due to the credit facility given to our
customers/clients.
• Credit facility allows our customers to buy from us today and

they are given certain period to pay the purchase amount.
• As long as the amount remain unpaid, it will appear in our

balance sheet under accounts receivables which refers to our
debtors.
• These debtors need to be handled and managed effectively to

prevent the amount owed from becoming bad debts.
The importance of how a firm manages its accounts receivable
depends on the degree to which the firm sells on credit.
Size of Investment in Accounts Receivable
The size is determined by:
• Percent of credit sales to total sales

o The nature of the business will determine the proportion of
credit sales.
o Beyond financial manager control.
• Level of sales
o More sales, the greater accounts receivable.
o Seasonal sales vs. permanent growth in sales
o Beyond financial manager control

Credit and collection policies
Under the control of the financial manager
 Terms of sale
 Type of customer
 Collection efforts
Terms of sale
 Quoted as a/b net c, which means, “deduct a % if paid within
b days, otherwise pay within c days”
Type of customer
 The use of credit scoring – the numerical credit evaluation of
each candidate to determine the type of customer who is to
qualify for trade credit
 Customers’ credit rating will be evaluated before credit facility

could be granted to them
 Granting credit facility to the wrong customers will result in

the increase in the chances of having bad debts
Example: Caltex Petrol Pump Business Working
Capital Requirement
Q&A

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CHAPTER 8

WORKING CAPITAL MANAGEMENT IN SMALL

Cash management and

In other words, working capital is a business’s investment in

This investment is needed in order to allow an entrepreneur

Some of the working capital elements (e.g. inventories) may

Net Working Capital (NWC)

Working capital is a measure of a company’s operational

Cash is needed among other working capital elements in

Cash is needed for the purpose of returning balance to

Without enough cash in hand, business transactions may not

For instance, total amount of cash that need to be maintained

And even though we have allocated enough cash for daily

However, in the event of surplus, the extra available cash

For example, entrepreneurs should think of investing any

Maintaining too much idle cash in business may not be a good

Three types of inventory:

 Material requirement planning (MRP)

It focuses on taking a decision regarding how much quantity of

 The delivery time is 20 days (Assume a 360 days a year in

1. determine the optimal Economic Order Quantity (EOQ) level

2. how many orders will be placed annually?

3. what is the average inventory level?

4. calculate the total inventory costs

5. what is the inventory order point?

• Credit facility allows our customers to buy from us today and

• As long as the amount remain unpaid, it will appear in our

• These debtors need to be handled and managed effectively to

• Percent of credit sales to total sales

o Seasonal sales vs. permanent growth in sales

o Beyond financial manager control

 Customers’ credit rating will be evaluated before credit facility

 Granting credit facility to the wrong customers will result in

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