Operating Cycle

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OPERATING CYCLE

The way working capital moves around the business is modeled by the working capital cycle.This shows the cash coming into the business,what happens to it while the business has it and then where it goes.the term operating cycle otherwise known as “cash cycle”.In order to earn sufficient profits,a firm has to depend on its sales activities apart from others.The continuing flow from cash to suppliers,to investors,to debtors and back in cash.The time gap is technically termed as operating cycle.In other words,the duration of the time required to complete the following sequence of events,in case of a manufacturing firm,Is called operating cycle.

1)Conversion of cash into raw materials
2)Conversion of raw materials into work-in-progress
3)conversion of work-in-progress into finished goods
4)conversion of finished goods in debtors
5)conversion of debtors to cash

Bewteen each stage of this working capital cycle there is time delay.For some business this will be very long where it takes them a long time to make and sell the product.They will need a substantial amount of working capital to survive.Others though may receive their cash very quickly after paying out for raw materials etc.They will need less working capital.

For all businesses though they need to plan how much cash they are going to have.The best way of doing this is a CASH FLOW FORECAST.

WORKING CAPITAL CYCLE

From the above chart,it can be observed that the firm’s liquidity of a minifacturing firm depends an operating cycle involved in the conversion process from raw materials into finished goods and then sales into cash.

In case of non-maifacturing firms,the operating cycle will include the length of the time required to convert:

a)Cash into inventories
b)Inventories into debtors
c)debtors nto cash

To determine the operating cycle period,time lag associated with all the individual activities of working cycle are to be determined first.Then summing up all the individual time lags working capital cycle is to be ascertained.Determine of individual time lags are shown as follows

Raw Materials Conversion Period
The RMCP denotes the period for which the raw materials are generally are kept in stores before it is issued to the production department.It is calculated as :

RMCP=
Average inventory of raw materials and stores
……………………………………………………………….. Averahe daily consumption of raw materials

Work-In-Progress conversion period(WPCP)
It refers to the period for which the raw materials remain in the production process before it is taken out as finished products.WPCP being done in the following ways :

WPCP=
Average work-in-progress
………………………………………………. Average daily factory cost of production

Finished Goods Conversion Period(FGCP)
It refers to the period for which finished goods remain in stores before being sld to the customers.It is measured as :

FGCP=
Average stock of finished goods
……………………………………………………….. Average cost of goods sold per days

Receiveable Collection Period(RCP)
It is the time required to convert the credit sales into cash realizations,i.e., the time allowed to debtors after credit sales for making the payment.

RCP=
Average debtors
…………………………………..
Average daily credit sales

Payment Deferral Period(PDP)
The firm may get sum credit facilities from the suppliers of raw materials,wage earners etc.As the firm enjoys credit,this period has the effect of the reducing money lock period in the operating cycle.

CPP=
Average creditors
………………………………………….
Average daily credit purchase
COMPUTATION OF WORKING CAPITAL IN BIRLA CORPORATION LIMITED

(Rs. In lakh)

As on 31.3.08 As at 31.3.07 As at 31.3.06 CURRENT ASSET
Inventories 20044.82...
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