Operating & Cash Conversion Cycle. The time taken for the completion of the cycle of the processes of conversion of raw material into finished goods, sale of goods, the realization of sale proceeds, and receipt of cash is termed the ‘Operating and Cash Conversion Cycle’ or ‘Working Capital Cycle.” The operating cycle of a company determines the requirements of working capital.
The period of the operating cycle of a manufacturing unit is the total time taken by the following two steps:
1) Inventory Conversion Period:
The ‘Inventory Conversion Period’ is the total time taken in the production and sale of the product from the raw material through the following:
i) Raw Material Conversion Period.
ii) Work-in-Progress Conversion Period.
iii) Finished Goods Conversion Period.
2) Debtors Conversion Period:
The time needed to realize the outstanding amount from the customers is the ‘Debtors Conversion Period’.
The total time taken by ‘The inventory Conversion Period’ and ‘Debtors Conversion Period’ is known as ‘Gross Operating Cycle.
The Gross Operating Cycle of any manufacturing unit may be obtained by taking the total of the days involved in each individual stage of the cycle as indicated below:
1) Purchase of ‘Raw Materials’ (RM) on cash payment,
2) Conversion of ‘Raw Material’ into Work-in-Process (WIP),
3) Conversion of work-in-process into ‘finished goods (FG),
4) Sale of ‘Finished Goods’ and conversion into ‘Accounts Receivables’ (Debtors and Bills Receivable), and
5) Realisation of sale proceeds (Accounts Receivables) and receipt of cash in due course of time.
The above operating cycle, which begins with the cash cycle depends upon (the purchase of raw materials) and ends with cash (realization of sale proceeds) is recurring in nature and the time taken for completion of one is the nature of the business a company is engaged into, and the kind of finished goods manufactured by it, credit period availed by it, credit period extended by it, etc.
The Net Operating Cycle
of a manufacturing unit may procure resources (raw material) on credit and the payment of miscellaneous expenses may also be deferred. Such credit or deferment may be considered a source of finance. The duration of time, for which a manufacturing unit is able to defer payment of RM and other expenses, is termed the ‘Creditor Deferral Period’ (CDP).
The difference between the ‘Gross Operating Cycle and the ‘Creditor Deferral Period’ is known as ‘Net Operating Cycle’, ‘Cash Cycle’ or ‘Cash Conversion (CCC). Some economists are of the view that during the calculation of ‘Cash Cycle’, ‘Depreciation” and ‘Profit’ needs to be excluded, as ‘Depreciation’ is a non-cash item and ‘Profit’ is not a cost. Thus, the cash cycle is the time gap between the amount of cash received from the sale of goods and payment made by the company for the delivered goods.
Determinants of Working Capital- Click here