CP

have used his inventories or receivables as security for the loan, but processing costs

would have been high.^17

For a more detailed discussion of secured financing, see the Web Extension to this

chapter.

What is a secured loan?

What are some types of current assets that are pledged as security for short-

term loans?

Summary

This chapter discussed working capital management and short-term financing. The

key concepts covered are listed below.


 Working capital refers to current assets, and net working capitalis defined as

current assets minus current liabilities. Net operating working capitalis defined

as operating current assets minus operating current liabilities.


 The cash conversion cycle modelfocuses on the length of time between when

the company makes payments and when it receives cash inflows.


 Theinventoryconversionperiodis the average time required to convert materials

into finished goods and then to sell those goods.

Inventory conversion period 
Inventory/Sales per day.

 The receivables collection periodis the average length of time required to con-

vert the firm’s receivables into cash, that is, to collect cash following a sale.

Receivables collection period 
DSO 
Receivables/(Sales/365).

 The payables deferral periodis the average length of time between the purchase

of materials and labor and the payment of cash for them.

Payables deferral period 
Payables/Purchases per day.

 The cash conversion cycleequals the length of time between the firm’s actual

cash expenditures to pay for productive resources (materials and labor) and its own

cash receipts from the sale of products (that is, the length of time between paying

for labor and materials and collecting on receivables).

 Under a relaxed working capital policy,a firm would hold relatively large

amounts of each type of current asset. Under a restricted working capital policy,

the firm would hold minimal amounts of these items.


 The primary goal of cash managementis to reduce the amount of cash to the

minimum necessary to conduct business.

Cash

conversion

cycle

Inventory

conversion

period



Receivables

collection

period



Payables

deferral

period

.

(^17) The term “asset-based financing” is often used as a synonym for “secured financing.” In recent years,
accounts receivable have been used as security for long-term bonds, and this permits corporations to borrow
from lenders such as pension funds rather than being restricted to banks and other traditional short-term
lenders.
Summary 611

606 Working Capital Management