Working Capital Management

Working capital management is associated with receiving and paying out cash. As is obvious, the companies tend to maximize the benefits of earning by paying as late as possible and getting paid as soon as possible.

This chapter provides various ways to maximize the benefits of working capital management and offers practical examples to understand the concepts.

Why Firms Hold Cash

Economist John Maynard Keynes suggested three main reasons why firms hold cash. The three reasons are for the purpose of speculation, precaution, and transactions. All of these three reasons arise from the necessity of companies to possess liquidity.


According to Keynes, speculation for holding cash is seen as creating the ability for a firm to take the benefits of special opportunities. These opportunities, if acted upon quickly, tend to favor the firm. An example of speculation is purchasing extra inventory at a discounted rate. This rate is usually far greater than the carrying costs of holding the inventory.


A precaution serves as a protectionist or emergency fund for a company. When the cash inflows are not received according to expectation, cash held on a precautionary basis can be utilized to satisfy the short-term obligations for which cash inflow may have been sought for.


Firms either create products or they provide services. The offer of services and creation of products results in the necessity for cash inflows and outflows. Firms may hold enough cash to satisfy their cash inflow and cash outflow needs that arise from time to time.


Float is the existing difference between the given book balance and the actual bank balance of an account. For example, you open a bank account, say, with $500. You do not receive any interest on the $500 and you also do not pay a fee to have the account.

Now, think what you do when you get a utility or water bill. You receive your water bill and say, it is for $100. You can write a check for $100 and then mail it to the particular water company. When you write the $100 check, you also file the transaction or payment in the bank register. The value your bank register reflects is the book value of the account. The check may be "in the mail" for a few days. Then after the water company receives, it may take several more days before it is cashed.

Now, between the moment you initiate or write the check and the moment the bank cashes the check, there will obviously be a difference in the book balance and the balance your bank lists for your checking account. That difference is known as float.

It is important to note that the float can be managed. If you already have the info that the bank will not get to know about your check for five days, you could also invest the $100 in a savings account at the bank for the five days. Then at the "just in time" you can replace the $100 in your checking account to cover the $100 check.

Time Book Balance Bank Balance
Time 0 (make deposit) $500 $500
Time 1 (write $100 check) $400 $500
Time 2 (bank receives check) $400 $400

Float is calculated by subtracting the book balance from the bank balance.

Float at Time 0: $500 − $500 = $0

Float at Time 1: $500 − $400 = $100

Float at Time 2: $400 − $400 = $0

Ways to Manage Cash

Firms need to manage cash in almost all areas of operations that have anything to do with cash. The goal of the firm is to get cash as soon as possible and at the same time, keep waiting to pay the cash out as long as possible. Some of the examples of how firms do this are discussed below.

Policy for Cash Being Held

A firm holding the cash tries to maximize its benefits and want to pay out the cash until the last possible moment. An example is given here.

In the last bank account example, say, you invest $500 in liquid investments rather than investing that amount in a checking account that pays no interest. Assume that the bank allows you to maintain a balance of $0 in your checking account.

Now, you can write a $100 check to the Water Company and then transfer funds in "just in time" (JIT) fashion. By employing this JIT system, you will get interest on the entire $500 till you need the $100 to pay the water company.

Firms often have such policies to maximize idle cash.


The goal here is to shorten the time to receive the cash as much as possible. Firms that make sales on credit tend to decrease the amount of time customers wait to pay the firm by offering discounts.

For example, credit sales are often made with terms such as 3/10 net 60. It means that a 3% discount on the sale when the payment is made within 10 days. The "net 60," term means that the bill is due within 60 days.


The goal now is to put off the payment of cash for as long as possible and to manage the cash being held. By using a JIT inventory system, a firm can delay paying for inventory until it is needed. The firm also avoids carrying costs on the inventory. The companies buy raw materials in JIT systems.

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