Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
*The shorter the cash conversion cycle, the better because that will lower interest charges.
Note: The aim of every management should be to reduce the length of operating cycle or the number of
operating cycles in a year in order to reduce the need for working capital. It is therefore necessary that
the financial managers be able to identify the reasons for prolonged operation cycle and how it could be
reduced.
Possible reasons for Longer Operating Cycle:
1. Defective purchasing policy and practices
-purchase of raw materials or merchandise in excess/short of requirements
-buying inferior, defective materials thus lengthening the production time
-failure to get credit from suppliers
-failure to get trade/cash discount, and
Financial Management 1
Technological Institute of the Philippines
2. Restricted Current Asset Investment Policy policy under which holdings of cash, securities,
inventories, and receivables are minimized. Marginal carrying costs of current assets will decrease while
marginal shortage of costs will increase.
3. Moderate Current Asset Investment Policy a policy that is between the relaxed and restricted
policies. This policy dictates that the firm will have just enough current assets so that the marginal
carrying costs and marginal shortage costs are equal, thereby minimizing total cost.
Effective working capital management requires a set of strategies to manage the level, composition, and
financing of a firms current assets. Decisions should be based on the simultaneous analysis of their joint
impact on return and risk.
Thus, consideration should be given on the broad categories of assets. These are:
1. Long Term/Permanent Assets consists of property,plant, and equipment, long term investments,
and the portion of firms current assets that remained unchanged over the year.
2. Fluctuating or Seasonal Assets current assets that vary over the year due to seasonal or cyclical
needs.
Financing Policies:
1. Flexible Financing Policy this involves the decision to finance the peaks of asset requirement with
long-term debt and equity. It provides the firm with a large investment surplus in cash and marketable
securities most of the time.
2. Restricted Financing Policy - this involves a decision to finance the valleys or troughs of assets, with
long-term debt and equity but will have to seek short-term financing for all peak demand fluctuations
for current assets as well as for in between demand situations. This policy is considered the most
conservative but the least convenient because it involves seeking some level of short-term financing
almost all of the time.
3. Compromise Financing Policy this involves a firm financing the seasonally adjusted average level of
asset demand with long-term debt and equity. It uses both short-term financing and short-term
investing as needed. With this compromise approach, the firm borrows in the short-term to cover peak
financing needs but it maintains a cash reserve in the form of marketable securities during slow
period. As current assets build up, the firm draws down this reserve before doing any short-term
borrowing. This allows for some run-up in current assets before the firm has to resort to short-term
borrowing.
Financial Management 1
Technological Institute of the Philippines
Financial Management 1
Technological Institute of the Philippines