Page 239 - DMGT207_MANAGEMENT_OF_FINANCES

Management of Finances

Notes Self Assessment

Fill in the blanks:
5. The greater the amount of working capital particularly cash and marketable securities the
lower the risk of ………………. problems.

6. A firm with readily available credit from banks will be able to plan for ……………….
working capital.

10.4 Working Capital Cycle (Operating Cycle)

The working capital cycle refers to the length of time from purchase of production inputs (raw
materials) entering the production process (work in progress when labour costs and factory
overheads are incurred), work in progress get converted into finished products, finished products
when sold on credit and get converted into Accounts Receivable and Debtors being realized in
cash after the expiry of the credit period. Thus, there is a complete cycle from cash to cash
wherein cash gets converted into raw materials, work in progress, finished goods, debtors and
finally into cash again. Short-term funds are required to meet the requirement of funds during
this time period. This time period is dependent upon the length of time within which the
original cash gets converted into cash again. This cycle is also known as operating cycle or cash
cycle.
The working capital cycle is depicted below:

Figure 10.2: Working Capital Cycle

Working Capital Cycle

Cash

Raw Materials
Labour, Overhead
Debtors

Work-in-progress

Finished Stock

Notes The determination of working capital cycle helps in the forecast, control and
management of working capital. It indicates the total time lag and the relative significance
of its constituent parts. The duration of working capital cycle may vary depending on the
nature of the business. The duration of the operating cycle for the purpose of estimating
working capital is equal to the sum of the duration of each of the above events less the
credit period allowed by the suppliers.

Example: A company holds raw materials on an average for 60 days, it gets credit from
the supplier for 15 days, production process needs 15 days, finished goods are held for 30 days
and 30 days of credit is extended to debtors. The total of all these days minus the credit days

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