CMA Intermediate · Financial Management and Business Data Analytics

Financing Working Capital: formula sheet

Full chapter guide

Key formulas

Total working capital need: Total working capital = Permanent working capital + Temporary working capital; Permanent is the minimum level always held; temporary is the seasonal or variable part above it.
Matching principle: Permanent needs → long-term sources; Temporary needs → short-term sources; This is the base rule for classifying sources in answers. Aggressive and conservative policies depart from it deliberately.
Net working capital: Net working capital = Current assets − Current liabilities; Trade credit and accruals are current liabilities, so they reduce the amount that needs other financing.
Effective cost of discounted bill or CP: Effective annual cost = (Discount ÷ Net amount received) × (365 ÷ Days); Use when a question asks the true yearly cost of a discounted instrument. Net amount received = Face value − Discount.
Permanent and temporary current assets: Temporary current assets = Total current assets − Permanent current assets; Permanent level is usually the minimum level of current assets during the year.
Matching approach funding: Long-term funds = Fixed assets + Permanent current assets; Short-term funds = Temporary current assets; Short-term funds vary month by month with temporary needs.
Conservative approach funding: Long-term funds = Fixed assets + Permanent current assets + Part (or all) of temporary current assets; Higher long-term funding than matching. Surplus funds in slack periods are idle or invested short term.
Aggressive approach funding: Short-term funds = Temporary current assets + Part of permanent current assets (+ sometimes part of fixed assets); Lower long-term funding than matching. Higher refinancing risk.
Net working capital: Net working capital = Current assets − Current liabilities; Highest under conservative, lowest under aggressive for the same asset base.
Financing cost: Annual interest = Σ (amount of source × rate × period in years); Use this to compare policies when rates of long-term and short-term sources are given.
Cost of forgoing cash discount (simple, annualised): Cost = [d ÷ (100 − d)] × [365 ÷ (N − D)] × 100%; d = discount %, N = credit period in days, D = discount period in days. Use 360 days if the question says so.
Cost of forgoing cash discount (effective, compounded): Effective cost = [1 + d ÷ (100 − d)]^(365 ÷ (N − D)) − 1; Use when the question asks for the effective annual rate or compounding.
Amount actually financed: Funds used = Invoice amount × (100 − d) ÷ 100; This is the cash price if you pay within the discount period.
Decision rule: Take the discount if cost of forgoing > cost of alternative finance; Otherwise pay on the last day of the credit period.
Effect of stretching payment: New cost = [d ÷ (100 − d)] × [365 ÷ (Actual payment day − D)]; Paying after the due date lowers the annual cost, but it may harm the supplier relationship and credit rating.
Commercial paper discount: Discount = Face value × Discount rate × Days ÷ 365; Net proceeds = Face value − Discount. Use 365 days unless the question says otherwise.
Effective annual cost of CP (simple): Cost = (Total cost ÷ Net amount received) × (365 ÷ Days); Total cost = discount + issue expenses such as rating, IPA and stamp charges. Use net amount received after all costs.
Effective annual cost of CP (compounded): Effective rate = (1 + Cost for the period ÷ Net amount)^(365 ÷ Days) − 1; Use only if the question asks for the effective or compounded rate.
Factor advance: Gross advance = Invoice value × Advance %; Interest = Gross advance × Rate × Credit period ÷ 365; Net advance received = Gross advance − Commission − Interest; Commission is charged on invoice value. Interest is calculated on the gross advance (before deductions) for the credit period. Read the question for what is deducted upfront.
Cost of factoring (annual): Cost % = (Commission + Interest) ÷ Net advance received × (365 ÷ Credit period); Compare with the benefits saved: collection costs, bad debts (non-recourse) and interest on funds freed.
Net benefit of factoring: Net benefit = Savings (admin cost + bad debts avoided + interest on freed funds) − Factoring cost; Accept factoring if net benefit is positive or the effective cost is below the alternative borrowing rate.

Quick revision

Permanent working capital is the minimum level of current assets always needed; temporary working capital varies with the season or activity.
Trade credit is spontaneous finance that arises from normal purchases.
Matching policy funds permanent needs with long-term sources and temporary needs with short-term sources.
Conservative policy uses more long-term finance: lower risk, usually higher cost.
Aggressive policy uses more short-term finance: higher risk, usually lower cost.
Cash credit and overdraft let you borrow up to a limit, and interest is charged on the amount actually used.
Compensating balances and commitment charges raise the effective cost of bank finance.
Cost of skipping a discount, in simple form: Discount ÷ (100 − Discount) × 365 ÷ (Credit period − Discount period).
Always compare the annualised cost of skipping the discount with the cost of borrowing to pay early.
Factoring converts receivables into cash; with recourse the seller keeps the bad-debt risk, without recourse the factor bears it.
Commercial paper is a short-term unsecured promissory note issued at a discount by creditworthy companies.
In a factoring decision, count the collection and bad-debt costs saved against the factor's fees and interest.

Common mistakes

Treating all working capital as temporary and financing it only with short-term funds. Fix: Remember that a minimum level of current assets is permanent. Finance that core with long-term funds under the matching principle.
Calling trade credit a costless source in every case. Fix: Trade credit is free only if you pay within the discount period. Forgoing a cash discount carries a real cost, which you calculate separately.
Calling short-term funding of temporary assets an aggressive policy. Fix: Short-term funds for temporary assets is the matching approach. It becomes aggressive only when short-term funds also finance permanent assets.
Taking the average current assets as permanent current assets. Fix: Use the minimum level of current assets over the year as the permanent part, unless the question defines it differently. The rest is temporary.
Using d ÷ 100 instead of d ÷ (100 − d). Fix: Always put 100 − d in the denominator. For 2%, divide by 98, not 100.
Using 30 days instead of 20 in the annualising factor. Fix: Use N − D. The 10 days before the discount deadline are not the extra credit.
Using face value as the denominator in the cost of commercial paper. Fix: Divide total cost by the net amount actually received, then annualise.
Leaving out issue expenses such as rating, IPA and stamp fees from the CP cost. Fix: Add all costs to the discount before dividing by net proceeds.

Exam tips

In theory answers, start by defining permanent and temporary working capital, then map sources. This structure is rewarded.
For 'discuss the sources' questions, give each source a feature, an advantage and a limitation in two or three lines.
In MCQs, test the tenure first. Options that use long-term funds for seasonal needs are usually wrong.
If a cost question gives days and discount, annualise using 365 ÷ days and say which basis you used.
Write the basis of any assumption, such as ignoring issue expenses, in one line so marks are protected.
Start every answer by splitting current assets into permanent and temporary. It earns step marks and prevents wrong classification.
For MCQs, find the one deciding clue: short-term funds on permanent assets means aggressive; long-term funds on temporary assets means conservative.
In written answers, always state both sides of the trade-off: cost (return) and risk (liquidity and refinancing). Examiners look for the pair.