WORKING CAPITAL

MANAGEMENT
MM 109 A
Managerial Accounting and Control

• MARC CHITO S. ITAO

• LOURD ANTHONY O.
DOLLANO
• GINA M. LANGUIS
 WORKING CAPITAL
MANAGEMENT

• Is an important yardstick to measure a company’s

operational and financial efficiency.
• Decisions relating to working capital and short term
financing are referred to as Working Capital
Management
• The goal is to ensure that the firm is able to continue its
operations and that it has sufficient cash flow to satisfy
both maturing short term debt and upcoming
operational expenses.
 MEASURES TO IMPROVE
WORKING CAPITAL
MANAGEMENT
1. Proper cash flow budgeting and forecasting.
2. Contingency plans to tide over unexpected events.
3. Corporate-wide application of cash generated at
one location that can be utilized at another by
having information access and internal systems to
move cash and good treasury practices.
4. Combine operational and financial skills and an all
encompassing view of the company’s operations to help
identify and implement strategies that generate short term
cash.
5. Effective management procedures in relation to
customers that will also improve customer service and free
up time to legitimate activities like sales, order entry, and
cash collection.
6. Plan inventory requirement in collaboration with
customers and suppliers.
 DEFINITIONS:
Working Capital Management - Generally deals with
managerial decisions regarding current assets and how
they are financed.
Working Capital – is the firm’s investment in current assets.
Net Working Capital - is the excess of the current assets
over current liabilities .
 USES OF WORKING
CAPITAL
• Working capital investments are made to support day-
to-day operations and sales activities. These includes:
1. The amount of cash and marketable securities on
hand.
2. The amount of credit you extend.
3. The amount and type of inventories on stock.
 OBJECTIVES OF WORKING
CAPITAL MANAGEMENT
1. Generating income for the business.
2. Reducing the amount of investment needed to support
sales and production.
3. Both generating income and reducing the amount of
investment needed to support sales and production.
 MANAGEMENT OF CASH
How to Maximize Cash Flow
a. Insuring that cash receipts are deposited daily.
b. Investing excess cash in short-term investments until
needed.
c. Longer float
d. Restricting, to the extent possible, minimum cash
balances required by lenders or bank providing lock-box or
other services
e. Utilizing lock-boxes, where cost is justified, to speed-up
the receipt of cash.
 MANAGEMENT
RESPONSIBILITIES
RELATING TO CASH
a. Prevent losses from fraud or theft.
b. Provide accurate accounting of cash receipts, cash
payments, and cash balances.
c. Maintain sufficient amount of cash at all times to
make necessary payments plus reasonable balance
for emergencies.
d. Prevent unnecessary large amounts of cash from
being held idle in back accounts, which produce no
revenue.
 MANAGEMENT OF
RECEIVABLES
a. Care should be taken in setting credit policy.
b. Approval of payment terms to insure that terms do
not result increased receivables without
corresponding increase in sales volume and
profitability.
c. Prepare and mail bills to customers on same day of
shipment.
d. Collections
 MANAGEMENT OF
INVENTORIES
Objectives:
a. Reduce inventories while maintaining customer service
levels and quality.
b. To establish production and inventory control.
Accountant’s Attention on Inventories:
1. Control
2. Information
3. Inventory Value
 INVENTORY PLANNING
AND CONTROL
smooth out the differences in time and location of
demand and supply

Purpose: to determine the optimum level of inventory

necessary to minimize cost.
 COST OF INVENTORIES
1. COST OF CARRYING (HOLDING):
a. Desired rate of return on investment
b. Risk of obsolescence and deterioration
c. Storage space cost
d. Property taxes
e. Insurance
2. COST OF ORDERING (SET-UP COSTS):
a. Preparing purchase or production orders.
b. Receiving (unloading, unpacking,
inspecting).
c. Processing all related documents.
d. Mailing and stationary costs.
e. Other costs like telephoning and typing
or orders.
3. STOCK-OUT SHORTAGE COSTS:
- include those costs incurred when item is out of stock.
 ECONOMIC ORDER
QUANTITY (EOQ)

The basic inventory problem facing a

firm is one of minimizing the Total Cost of the
Inventories.
In solving this problem, the firm also has
to avoid the possibility of any stock-outs,
which would result in:
a. Customer Loss
b. Customer Dissatisfaction
 ECONOMIC ORDER
QUANTITY (EOQ)

- The number of units that a company should

add to inventory with each order to minimize
the total costs of inventory - such as holding costs,
order costs, and shortage costs.

- The Order Size of the appropriate number of

units that should be ordered.
 ECONOMIC ORDER
QUANTITY (EOQ)
Minimizing Total Inventory Cost (Cost of Ordering + Cost
of Carrying) can be dealt with the use of the Economic
Order Quantity Model:

2xDxO
EOQ = C
Where:
D = Demand annually for the product
O = Order Cost per order placed
C = Carrying Cost annually per unit of the product
in the inventory
 ECONOMIC ORDER
QUANTITY (EOQ)
• Demand – the quantity of good that consumers are
willing and able to purchase at various prices during a
given period of time.
• Ordering Cost – expenses incurred to create and process
an order to a supplier. This costs are included in the
determination of the economic order quantity for an
inventory item. Examples are: 1. Cost to prepare a
purchase requisition, 2. Cost to prepare a purchase
order.
• Carrying Cost (Holding Cost) – the total cost of holding
inventory. This includes warehousing costs such as rent,
utilities and salaries, financial costs such as opportunity
cost and inventory costs related to perishability,
shrinkage (leakage) and insurance.
 FORMULAS:
TOTAL INVENTORY COST (TIC) = Total Annual Carrying Costs (TAC) + Total
Ordering Costs (TOC)
or
TIC = TAC* + TOC**

TAC* = Average Inventory Level x Annual Carrying Cost per Unit

Average Inventory = Order Size ÷ 2
TOC** = No. of Orders x Cost per Order
No. of Orders = Annual Demand ÷ Order Size
• Reorder Point – this level represents when to place the order for the order quantity (size)
Reorder Point = (Delivery Time* expressed in the same units as the Demand x (Demand)

• Delivery (lead) Time* - time interval between placing an order and receiving delivery

• Safety Stock – inventory carried over and above the quantity determined by the EOQ
formula to meet unanticipated demand.
 EXAMPLE PROBLEM:
Brady Sporting Goods, Inc. buys baseballs at 200 per dozen from
its wholesaler. Brady will sell 36,000 dozen baseballs evenly
throughout the year. Brady desires a 10% return on its inventory
investment. In addition, rent, insurance, taxes, etc., for each
dozen baseballs - inventory is 4.00. The administrative cost
involved in handling each purchase order is 100.

REQUIRED:

1. Determine the Economic Order Quantity (EOQ) in dozens;

2. Assuming Brady ordered in order sizes of 800 dozen evenly
throughout the year, determine the Total Annual Inventory
Costs to sell 36,000 dozen baseballs;
3. Assuming that it takes 3 working days to receive the order
once it is placed, determine when Brady should place an
order (Reorder Point). Assume a 300-day year
 EXAMPLE PROBLEM:

Brady Sporting Goods, Inc. buys baseballs at 200 per dozen from
its wholesaler. Brady will sell 36,000 dozen baseballs evenly
throughout the year. Brady desires a 10% return on its inventory
investment. In addition, rent, insurance, taxes, etc., for each
dozen baseballs - inventory is 4.00. The administrative cost
involved in handling each purchase order is 100.

SOLUTION: Determine EOQ

1. EOQ = 2xDxO = 2x36,000x100 =548 Dozens

C 24

* Carrying Cost per Dozen = (10% x 200) + 4 = 24

 EXAMPLE PROBLEM:

Brady Sporting Goods, Inc. buys baseballs at 200 per dozen from its
wholesaler. Brady will sell 36,000 dozen baseballs evenly throughout the
year. Brady desires a 10% return on its inventory investment. In addition,
rent, insurance, taxes, etc., for each dozen baseballs - inventory is 4.00.
The administrative cost involved in handling each purchase order is 100.
SOLUTION: Assuming Brady ordered in order sizes of 800 dozen evenly
throughout the year, determine the Total Annual Inventory Costs
to sell 36,000 dozen baseballs.
2. Total Inventory Cost (TIC) = (400*x24) ÷ (45**x100)
= 14,100
o Average Inventory = 800 ÷ 2 =400* Dozens
o No. of Orders = 36,000 ÷ 800 =45**
o 2 is always used as divisor to get the average inventory based on the EOQ
formula
 EXAMPLE PROBLEM:

Brady Sporting Goods, Inc. buys baseballs at 200 per dozen from its
wholesaler. Brady will sell 36,000 dozen baseballs evenly throughout the
year. Brady desires a 10% return on its inventory investment. In addition,
rent, insurance, taxes, etc., for each dozen baseballs - inventory is 4.00.
The administrative cost involved in handling each purchase order is 100.
SOLUTION: Assuming that it takes 3 working days to receive the order
once it is placed, determine when Brady should place an order
(Reorder Point). Assume a 300-day year
3. Lead Time expressed in the same units as the demand:
3 days/300days = 0.01 year or 1%
Reorder Point = 0.01x36,000 = 360 Dozens
or
Reorder Point = Daily Demand x Lead Time
Daily Demand = 36,000 ÷ 300 = 120 Dozens
Lead Time = 3 days
Reorder Point = 120 x 3 = 360 Dozens
 JUST-IN-TIME (JIT) MANUFACTURING

Just-in-Time Manufacturing
 A philosophy that focuses on timing, efficiency, and quality in meeting
commitments;
 A Demand-Pull, rather than the traditional “Push” approach;
 Has as its principal goal the elimination of waste, save time & space,
and promote a smooth and rapid flow of materials and components
into finished products.

Just-in-Time Inventory – a method of managing, purchasing, production

and sales, where the firm attempts to produce each item as
needed for the next step in the production process, or where the
firm attempts to time purchase so that items arrive just in time. This
practice can reduce inventory levels virtually to zero.
 COMPARISONS:
JIT MANUFACTURING TRADITIONAL
MANUFACTURING
1. Pull System Push System
2. Insignificant or Zero Significant Inventories
Inventories
3. Manufacturing Cells “Process” Structure
4. Multifunction Labor Specialized Labor
5. Total Quality Acceptable Quality
Management Level
6. Simple Cost Complex Cost
Accounting Accounting
 JUST-IN-TIME COSTING SYSTEM

Just-in-Time Costing System is simple:

Materials and Work-in-Process accounts are
combined into one account called “Resources in
Process”;
Stores Control Account is eliminated because
Materials are immediately brought to the production
area;
For materials, manufacturing overhead and labor
that are purchased and incurred and right away put
into process maybe immediately charged to Cost of
Goods Sold and credit Cost of Goods Sold for the
costs of finished goods unsold.
 ADVANTAGES (BENEFITS) OF JIT:

1. JIT practice reduces inventory levels, which means lower

investments in inventories;
2. JIT greatly improves lead-time reliability due to shorter delivery
lead-time;
3. Reduced lead time and set-up time increases scheduling
flexibility;
4. Many companies have reported improved quality levels;
5. Extensive valued analysis reduces costs of purchased
materials;
6. Lower investments in factory space for inventories and
production;
7. Less obsolescence risk in inventories and less paper work;
8. Reduction in scrap and rework.
 TOTAL QUALITY MANAGEMENT (TQM):

• TQM means the organization is managed to excel on

all dimensions, and the customer ultimately defines
quality.
• A system for creating competitive advantage by
focusing the organization on what is important to the
customer.
• Essentially an endless search for perfect quality and it
is a Zero-defect approach.
• This approach to quality is opposed to the traditional,
acceptable quality level (AQL), which allows a
predetermined level of defective units to be
produced and sold.
 QUALITY COST AND
PERFORMANCE REPORTS

QUALITY COSTS are classified into:

1. Prevention Costs - costs incurred to prevent defects. They
are amounts spent on quality training programs,
researching customer needs, quality circles and improved
production equipment.
2. Appraisal Costs - costs incurred for monitoring or inspection.
They are costs incurred for monitoring or inspection.
3. Failure Costs - may be internal or external.
a. Internal Failure Costs are likely scrap and rework costs and re-
inspection.
b. External Failure Costs are costs due to product returns,
warranty costs, lost sales due to poor product performance
and complaint department costs.
 QUALITY COST AND
PERFORMANCE REPORTS
PERFORMANCE REPORTS:
The first step in a quality cost reporting system is to prepare a
detailed listing of actual quality costs by category and each
category of quality costs is expressed as a percentage of sales.
This serves two purpose:
1. It permits managers to assess the financial impact of quality
costs;
2. It reveals the relative emphasis currently placed on each
category.
Quality Performance Report - measures the progress achieved with the
period relative to the planned level of progress for the period.
One Year Quality Trend Report - compares the current year’s quality cost ratio
with the previous year’s ratio.
Long-Range Quality Performance Report - compares the current year’s actual
quality costs with the firm’s intended long-range quality goals.
 THANK YOU FOR
LISTENING!

“That in all things,

God may be
glorified!”