A treasurer holds $50M in receivables and $30M in inventory. Working capital management decides how much liquidity to hold, how to finance it, and what each day of float is worth.
Working capital is current assets: cash, marketable securities, receivables, inventory. Net working capital subtracts current liabilities. Short-term cash forecasts (weekly or monthly) tell the treasurer when to draw credit, invest a surplus, or release a payment. Cost management balances carrying cost (idle cash, AR financing, warehousing) against shortage cost (stockouts, missed discounts, emergency borrowing). The optimal strategy meets the stated liquidity objective at the lowest total cost.
Cash levels depend on cash-flow size, predictability, borrowing capacity, and risk tolerance. The three motives:
- Transaction: routine bills.
- Precautionary: forecast buffer.
- Speculative: unplanned opportunities.
Cash forecasts roll receipts and disbursements forward to surface gaps early.
Speed collections to shrink float:
- Lockbox: customers mail to a bank P.O. box swept several times daily.
- Concentration banking: regional deposit balances swept into one central account.
Common mistakes
- Treating compensating balances as free. A $1M loan with 15% compensating balance funds only $850,000 and lifts EAR. Add any commitment fee to the numerator.
- Confusing WC with NWC. Working capital = current assets. Net working capital subtracts current liabilities.
- Computing cash-discount cost without grossing up. Denominator is (1 − discount). 2/10 net 30 is 2/98, not 2/100.
Bottom line
- Working capital = current assets. Net working capital = current assets minus current liabilities.
- Three cash motives: transaction, precautionary, speculative (speculative funds unplanned opportunities).
- Lockbox is profitable when float-day interest savings exceed bank fees.
- Marketable security choice trades off safety, liquidity, yield, maturity, and taxability.
Exam shortcut
When the stem gives stated rate + compensating balance (or commitment fee), EAR = (interest + commitment fee) / usable proceeds, where usable = principal × (1 − comp%). When the stem asks cost of trade credit, use (d/(1−d)) × (365/(net − discount days)). Skipping 2/10 net 30 ≈ 37%; 2/10 net 40 ≈ 25%.
The full lesson (about 1,490 words, 10 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 2B4
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