Chapter 31: Working Capital Management

The text defines net working capital as the difference between current assets—such as cash, marketable securities, accounts receivable, and inventories—and current liabilities like accounts payable and short-term debt. A central analytical framework introduced is the cash cycle, which calculates the time lag between cash outflows for raw materials and cash inflows from sales, distinguishing it from the operating cycle by accounting for the accounts payable deferral period. The discussion on inventory management highlights the critical trade-off between carrying costs, such as storage and capital opportunity costs, and ordering costs or stockout risks. This section details the Economic Order Quantity (EOQ) model for minimizing total inventory costs and contrasts traditional buffering strategies with modern Just-In-Time (JIT) systems that rely on supply chain efficiency to maintain minimal stock levels. The chapter then transitions to accounts receivable management, breaking the process down into setting terms of sale, assessing customer creditworthiness, making credit decisions, and establishing collection policies. It explains how trade credit terms, such as discounts for early payment (e.g., 2/10 net 30), create implicit interest rates for customers who forgo cash discounts, effectively serving as a form of expensive short-term financing. The text explores methods for credit analysis, including the use of credit agencies and financial statement review, and presents the decision to grant credit as a calculation of expected profit versus the probability of default and the potential value of repeat business. Furthermore, the chapter addresses cash management efficiency, focusing on techniques to accelerate collections and manage disbursements, such as the use of lockbox systems, concentration banking, and electronic funds transfers via ACH, Fedwire, and CHIPS. It also touches upon international cash management complexities, including netting systems for multinational operations. Finally, the summary covers the investment of surplus cash into money market instruments. It categorizes various short-term investment vehicles based on liquidity, safety, and tax implications, including U.S. Treasury bills, federal agency securities, commercial paper, negotiable certificates of deposit (CDs), repurchase agreements (repos), and tax-exempt municipal notes, while also explaining the mechanics of calculating yields on these discount-based securities.