The Working Capital Cycle is also known as operating cycle. It refers to the duration between the firm’s 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.
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Debtors Credit Sales
Cash Sales
Administrative & S/D Expenditure Sales
Raw Materials WIP Finished Goods |
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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:
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
