Cash Operating Cycle: How to Manage Your Working Capital Efficiently
14 Dec 2023
14 min read
The cash operating cycle is the period of time which elapses between the point at which cash begins to be expended on the production of a product and the collection of cash from a customer.
The cash operating cycle (also known as the working capital cycle or the cash conversion cycle) is the number of days between paying suppliers and receiving cash from sales.
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Phases of the Cash Cycle
The cash operating cycle is made up of four (4) major phases.
These are explained by the slides that follow.
Phase 1: Purchase of Raw-materials
The chain starts with the firm buying raw materials on credit.
In due course this stock will be used in production, work will be carried out on the stock, and it will become part of the firm’s work in progress (WIP).
Phase 2: Work-in-Progress
Work will continue on the WIP until it eventually emerges as the finished product.
As production progresses, labour costs and overheads will need to be incurred, of course at some stage trade creditors will need to be paid as well.
Phase 3: Finished Goods
When the finished goods are sold on credit, debtors are increased.
Phase 4: Debtors
When debtors eventually pay, cash will be injected back into the firm.
Each of the stages – stocks (raw materials, work in progress and finished goods), trade debtors, cash (positive or negative) and trade creditors – can be viewed as tanks into and from which funds flow.
Determining the Cash Cycle
The cash operating cycle in a manufacturing business equals;
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Activity Question (Exam Type)
You have been provided with the following annual projections to help determine the cash operating cycle of MUL:
All raw material purchases are expected to be made on credit while 80% of the annual sales will be made on credit. The annual average receivables and payables are estimated at Shs 845 million and Shs 457 million, respectively.
Required:
Determine MUL’s projected cash operating cycle assuming 365 days in a year.
SOLUTION
About the Writer
CPA Innocent MUGISHA
CPA Innocent Mugisha is a Professor of Finance and Accounting with over 10 years experience in teaching Accounting and Finance related courses including Financial Accounting both at University and Professional level. His qualifications are: PhD (candidate), MBA(Finance), CPA(U), FCCA, CIPS, CTA and BCOM (Accounting). Innocent has also published various books on most topics in Accounting and Finance for Business and Professional Studies.
