Net Working Capital and CCC
Net Working Capital and CCC
Net Working Capital and CCC
BASIC CONCEPTS:
current assets
Net Working Capital – the excess of current assets over the current liabilities
current liabilities to ensure that they are adequate and used effectively for business
purposes
creditors look to the current assets as a source of repayment of their claims. The working
capital also indicates the amount by which the value of current assets could drop from
their book values and still cover the claims of short-term creditors without loss.
The amount of working capital represents the extent to which current assets are
financed from long-term sources – Although current assets are turned over within
relatively short periods, they always represent some percentage of sales. In this sense, a
General nature of the business and product – Trading and manufacturing companies
usually require higher proportions of current assets than service and utility companies do.
Effect of sales pattern - The working capital needs will be affected by the nature of the
change in sales or business activity. If the change in sales is brought about by cyclical or
seasonal changes, the periodic build-up of receivables and inventory is temporary and
investments into cash will come in the normal course of operation. If the change in sales
manufacture the products of the company, the higher the level of working capital
requirement is.
Industry practices – the industry or line of business with greater proportion of assets
readily convertible to cash can afford to have lower working capital investment and a
Terms of purchase and sales – the longer the credit period granted by suppliers of
merchandise is, the lower the requirement for permanent working capital is. Meanwhile,
the longer the credit period given to customer of the firm is, the higher the requirement
The company can settle its debts promptly thereby enabling it to maintain its good credit
standing
Credit may be extended to customers thereby increasing the sales volume of the firm
The company may not be able to pursue its objectives because of lack of funds
The current assets a firm needs in order to continue operations. Examples include inventory
and perhaps rapidly depreciating assets such as computers. These assets are current because
they do not remain assets for longer than a year, but they are permanent because they must be
replaced with similar assets. Despite the seeming contradiction in the name, they are called
permanent current assets because every company must permanently maintain a certain
TEMPORARY ASSETS
A subset of a company’s current assets that changes according to seasonal fluctuations. For
example, a retail store’s current inventory may include holiday decorations around
Christmas. These decorations would be temporary assets with respect to the remainder of the
store’s inventory.
which relatively large amount of cash, marketable securities and inventories are carried and
under which sales are stimulated by liberal credit policy, resulting in a high level of
receivables. This policy generally provides the lowest expected return on investment because
capital tied up in current assets either does not earn any substantial income at all or a minimal
Under relaxed policy, the company maintains current assets up to the level of ‘C2’ for the
same level of sales (S) as in restricted policy. It allows the company to have sufficient
changes in sales etc. The level of investment in current assets is high, which results in lesser
Aggressive or Restricted current asset investment policy – In this policy, the firm has
fewer liquid assets with which to prevent a possible financial failure. Holdings in cash,
securities, investors, and receivables are minimized. While risk of financial failure is high
because of the small amount of total capital commitment, the profitability rate measured by
assets level of ‘C’. Under this policy the company maintains lower investments in current
assets represent aggressive approach; intend to yield high return and accepting higher risk.
The management is ready to counter any financial difficulties arising out of restricted policy.
The level of investment in current assets is lesser and high risk is perceived for increase of
Moderate current assets investment policy – This is a policy that is between the
In moderate policy, the investment in currents lies in between ‘C’ and ‘C2‘. With this policy,
the expected profitability and risk levels fall between relaxed policy and restricted policy.
The higher the level of investment in current assets represents the liberal working capital
policy, in which the risk level is less and also the marginal return is also lesser.
Illustration:
The financing pattern, current ratio, profitability net working capital position is explained
under conservative, moderate and aggressive working capital policies are explained by way
Analysis:
We can observe from the above analysis that current ratio is 4 times if conservative policy is
followed; it has dropped to 1.5 in management of working capital under aggressive policy.
However, the return on investment has increased from 16.95% to 19.71%, if aggressive approach
is adopted. Higher risk is attached with the higher return, under aggressive policy.
In conservative approach majority of current assets are financed from long-term sources of
finance. When it comes to financing current assets under aggressive approach, majority of
The moderate policy stands in between two extremes of conservative and aggressive financing
approaches. Majority of the corporate follow the moderate policy of working capital financing,
which enables to avoid higher risk and to earn moderate profit margin on additional investments
in current assets.
firm's assets is matched with the maturity of the firm's liabilities. This means that all long-
term assets including the permanent level of current assets are financed with long-term
sources of financing. Temporary current assets are financed with short-term debt.
Aggressive Approach - the firm uses some short-term debt to finance some of its
permanent level of current assets, which means the firm must raise even more short-term
debt during seasonal fluctuations. The firm is "rolling over" short-term and using it more as
a permanent source of financing. This is considered a risky approach with high potential for
return.
Conservative Approach - the firm uses long-term financing for all of its long-term
assets, permanent current assets, and even some of it temporary current assets. The firm has
periods of excess liquidity (cash) where the firm invests in marketable securities but relies
less on short-term debt during seasonal fluctuations. This is considered a low risk approach
These lines indicate the extent of utilization of long-term sources. Higher the line, bigger is
RISK-RETURN TRADEOFF
The risk-return tradeoff states that the potential return rises with an increase in risk. Using this
principle, individuals associate low levels of uncertainty with low potential returns, and high
levels of uncertainty or risk with high potential returns. According to the risk-return tradeoff,
invested money can render higher profits only if the investor will accept a higher possibility of
losses.
CASH CONVERSION CYCLE
Cash Conversion Cycle (CCC) also known as net trade cycle, measures how fast a company
can convert cash on hand into inventory and accounts payable, through sales and accounts
Reported by:
CATHERINE H. CAPIAN