CAT / FIA FFM Syllabus A. Working Capital Management - Cash Operating Cycle - Notes 2 / 8
Cash operating cycle (working capital cycle)
This is the time between cash paid for raw materials and cash received from customers.
Day 1 Buy an item on credit (Payable)
Day 5 Sell the item on credit (Receivable)
Day 8 Pay for the item
Day 10 Receive the cash for the item
| How long is the item in stock for? | 4 days |
| How long is the receivable period? | 5 days |
| How long is the payable period? | 7 days |
| How long between having to pay and receiving the cash? | 2 days |
The 2 days is the cash operating cycle. It is how long between paying for an item and eventually receiving the cash.
This period needs funding somehow
Look again at the illustration and you may see how it is calculated:
| Inventory Days | 4 days |
| Receivable days | 5 days |
| Payable days | (7 days) |
| Cash operating cycle | 2 days |
Note the CASH needed in the gap can get bigger by:
Cycle gets longer (need more cash in proportion to the extra days in cycle)
Sales increase (need more cash in proportion to the extra sales made)
The length of the cycle will depend upon:
Liquidity v profitability decisions (eg credit terms offered)
Management efficiency
Industry norms (supermarkets very short - construction industry very long)
An increase in the length of the cash operating cycle will increase the level of investment in working capital.
Nature of business operations
Different industries have, not surprisingly, different cash operating cycles.
My academies, for example, hold very little stock (because I’m tight?) - er no because we sell services!
Compare that to WeSellLotsofStuff plc who hold lots of stuff (inventories).
Many retailers sell direct to the smelly, unwashed public and so have very few receivables - others sell to other businesses and so offer credit terms.
If an operating cycle is long, then there is lower accessibility to cash for satisfying liabilities for the short term.
A short cash cycle reflects sound management of working capital. A long cash cycle denotes that capital is occupied when the commercial entity is expecting its clients to make payments.
Negative cash operating cycle
Here they are getting payments from the clients before any payment is made to the suppliers.
Instances of such business entities are commonly those companies, which apply Just in Time techniques, for example Dell, as well as commercial enterprises, which purchase on credit and sell for cash, for instance Tesco.