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2. WORKING CAPITAL CYCLE

 

The Working Capital    Cycle is also known as operating cycle. It refers to the duration between the firmís payment of cash for raw materials, entering into production and inflow of cash from debtors and realization of receivables. Simply speaking, operating cycle is the duration between outflow of cash and this may be evidenced from the working capital cycle.

 

 

 

                        Debtors                                                              Credit Sales

 

                                                                                                   Cash Sales

                                                                                                                                                                                                                                                                                                                                                                                                                                         

 

 

 

                                                            Administrative & S/D Expenditure   Sales

 

 

 

 

 

 

      

 

 

 

 

 

 

 

 

 

Raw Materials      WIP                                             Finished Goods

Text Box:  
 
                        Debtors                                                              Credit Sales
 
                                                                                                   Cash Sales
                                                                                                                                                                                                                                                                                                                                                                                                                                         
 
 
 
                                                            Administrative & S/D Expenditure   Sales
 
 
 
 
 
 
       
 
 
 
 
 
 
 
 
 
Raw Materials      WIP                                             Finished Goods

CASH

Text Box: CASH

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The above network diagram may offer a clear picture of a complete working capital i.e. it is a cash to cash phenomenon. In the diagram, Raw material stock refers to material only. In WIP, components involve are raw materials, wages and overheads- more specifically manufacturing overhead. Finished stock consists component of material, wages, and selling and distribution overheads. Debtors include materials, wages, overheads and profit. Creditors involve for the components of raw materials etc. while estimating the working capital requirement.

 

The operating cycle consists of the following events which continues throughout the life of a firm remaining engaged in commercial activities:

              I.      Conversion of cash into raw materials.

           II.      Conversion of raw materials in WIP

         III.      Conversion of WIP into finished goods.

        IV.      Conversion of finished goods into account receivable and Debtors through sales.

           V.      Conversion of Accounts receivable into cash.

 

Calculation Of Working Capital Cycle:

 

So far we have discussed about nature and scope of working capital cycle. The finance manager must be prepared to know the exact period of operating cycle as because he has to plan for ensuring liquidity and profitability of the concern. Component wise working capital cycle-period can be ascertained as below:

 

                                                                          Average stock of Raw Materials

              I.      Raw material holding period   =   -------------------------------------------------

                                                                    Average Cost of Consumption per day     

 

                                                                                     Average WIP

           II.      WIP holding period                  =   --------------------------------------------------

        Average Cost of Production per day        

 

                                                                        Average stock of Finished Goods

         III.      Finished Goods holding             =    -------------------------------------------------

Period                                             Average Cost of Finished Goods per day

 

                                                                      Average Book Credit

        IV.      Receivable and Debtors            =    -------------------------------------------------

Collection period                                       Average credit sale per day

 

                                                                     Average Trade Creditors

           V.      Credit period allowed by          =     ------------------------------------------------

Sundry Creditors                                  Average credit purchase per day

In the form of a simple equation, working capital cycle can be represented as below:

 

                         WWC = R + W + F + D + B Ė C

 

Where, WWC= Working Capital Cycle

R= Raw Materials

W= Work in progress

F= Finished Stock

B=Cash at Bank  

D= Debtors and Receivable collection period

C= Credit period available

 

 

 

 

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