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CHAPTER

M

ost of this book is devoted to long-term financial

decisions such as capital budgeting and the choice of

capital structure. It is now time to look at the management

of the firm’s short-term assets and liabilities. Short-term,

or current, assets and liabilities are collectively known as

working capital. Table 30.1 gives a breakdown of working

capital for all manufacturing corporations in the United States

in 2014. Note that current assets are larger than current

liabilities. Net working capital (current assets less current

liabilities) is positive.

Look also at Figure 30.1, which shows the relative impor-

tance of working capital in different industries. For example,

current assets constitute over 50% of the total assets of tele-

com companies, while they account for less than 10% of the

assets of railroads. For some companies “current assets”

means principally inventory; in others it means accounts

receivable or cash and securities. For example, you can see

that inventory constitutes the majority of the current assets of

retail firms, receivables are more important for oil companies,

and cash and short-term securities make up the bulk of the

current assets of software companies.

In this chapter we focus on the four principal types of cur-

rent asset. We look first at the management of inventory. To

do business, firms need reserves of raw materials, work in

process, and finished goods. But these inventories can be

expensive to store and they tie up capital. Therefore, inventory

management involves a trade-off between the advantages

of holding large inventories and the costs. In manufacturing

companies, the production manager is best placed to make

this judgment, and the financial manager is not usually directly

involved in inventory management. So we spend less time on

this topic than on the management of other current assets.

Our second task is to look at accounts receivable. Com-

panies frequently sell goods on credit, so that it may be

weeks or even months before the company is paid. These

unpaid bills are shown in the accounts as receivables. We

explain how the company’s credit manager sets the terms

for payment, decides which customers should be offered

credit, and ensures that they pay promptly. Table 30.1 shows

that firms in the United States have about the same amount

invested in accounts receivable as in inventories.

Our next topic is the firm’s cash balances. The cash man-

ager faces two principal problems. The first is to decide how

much cash the firm needs to retain and, therefore, how much

can be invested in interest-bearing securities. The second

is to ensure that cash payments are handled efficiently. You

don’t want to stuff incoming checks into your desk drawer

until you can get around to going to the bank; you want to

get the money into your bank account as quickly as possible.

We describe some of the techniques that firms use to move

money around efficiently.

Cash that is not required immediately is usually invested in

a variety of short-term securities. Some of these literally pay

off the next day; others may mature in a few months. In the

final section we describe the different features of these secu-

rities and show how to compare their yields.

Working Capital Management

30

Part 9 Financial Planning and Working Capital Management