2019 Curriculum CFA Program Level I Corporate Finance

Working Capital Management

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The focus of this reading is on the short-term aspects of corporate finance activities collectively referred to as working capital management. The goal of effective working capital management is to ensure that a company has adequate ready access to the funds necessary for day-to-day operating expenses, while at the same time making sure that the company’s assets are invested in the most productive way. Achieving this goal requires a balancing of concerns. Insufficient access to cash could ultimately lead to severe restructuring of a company by selling off assets, reorganization via bankruptcy proceedings, or final liquidation of the company. On the other hand, excessive investment in cash and liquid assets may not be the best use of company resources.

Effective working capital management encompasses several aspects of short-term finance: maintaining adequate levels of cash, converting short-term assets (i.e., accounts receivable and inventory) into cash, and controlling outgoing payments to vendors, employees, and others. To do this successfully, companies invest short-term funds in working capital portfolios of short-dated, highly liquid securities, or they maintain credit reserves in the form of bank lines of credit or access to financing by issuing commercial paper or other money market instruments.

Working capital management is a broad-based function. Effective execution requires managing and coordinating several tasks within the company, including managing short-term investments, granting credit to customers and collecting on this credit, managing inventory, and managing payables. Effective working capital management also requires reliable cash forecasts, as well as current and accurate information on transactions and bank balances.

Both internal and external factors influence working capital needs; we summarize them in Exhibit 1.

Exhibit 1      Internal and External Factors That Affect Working Capital Needs

            Internal Factors             External Factors 
  •  Company size and growth rates 
  •  Banking services
  •  Organizational structure
  •  Interest rates
  •  Sophistication of working capital management
  •  New technologies and new products
  • Borrowing and investing positions/activities/ capacities
  •  The economy
  •  Competitors

The scope of working capital management includes transactions, relations, analyses, and focus:

  • Transactions include payments for trade, financing, and investment.
  • Relations with financial institutions and trading partners must be maintained to ensure that the transactions work effectively.
  • Analyses of working capital management activities are required so that appropriate strategies can be formulated and implemented.
  • Focus requires that organizations of all sizes today must have a global viewpoint with strong emphasis on liquidity.

In this reading, we examine the different types of working capital and the management issues associated with each. We also look at methods of evaluating the effectiveness of working capital management.

Learning Outcomes

The candidate should be able to:

  1. describe primary and secondary sources of liquidity and factors that influence a company’s liquidity position;
  2. compare a company’s liquidity measures with those of peer companies;
  3. evaluate working capital effectiveness of a company based on its operating and cash conversion cycles and compare the company’s effectiveness with that of peer companies;
  4. describe how different types of cash flows affect a company’s net daily cash position;
  5. calculate and interpret comparable yields on various securities, compare portfolio returns against a standard benchmark, and evaluate a company’s short-term investment policy guidelines;
  6. evaluate a company’s management of accounts receivable, inventory, and accounts payable over time and compared to peer companies;
  7. evaluate the choices of short-term funding available to a company and recommend a financing method.


In this reading, we considered a key aspect of financial management: the management of a company's working capital. This aspect of finance is a critical one in that it ensures, if done effectively, that the company will stay solvent and remain in business. If done improperly, the results can be disastrous for the company.

Working capital management covers a wide range of activities, most of which are focused on or involve the company's cash levels. Competing uses for the company's cash, which is often a scarce resource, create the need for an efficient method of handling the short-term financing of company activities.

Major points that were covered in this reading:

  • Understanding how to evaluate a company's liquidity position.
  • Calculating and interpreting operating and cash conversion cycles.
  • Evaluating overall working capital effectiveness of a company and comparing it with other peer companies.
  • Identifying the components of a cash forecast to be able to prepare a short-term (i.e., up to one year) cash forecast.
  • Understanding the common types of short-term investments, and computing comparable yields on securities.
  • Measuring the performance of a company's accounts receivable function.
  • Measuring the financial performance of a company's inventory management function.
  • Measuring the performance of a company's accounts payable function.
  • Evaluating the short-term financing choices available to a company and recommending a financing method.

Working capital management is an integral part of the financial management of a company because many short-term activities have effects on long-term financial decisions. Having an effective short-term financial strategy, for example, allows a company to plan ahead with the confidence that its short-term concerns are being handled properly. Perhaps unlike other areas of finance, short-term finance has more qualitative features, making each company's case somewhat different from another's. This unique nature, combined with the short time frame associated with this aspect of finance, makes short-term finance a dynamic, challenging activity.

1.5 CE

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