How to calculate Working Capital Cycle or Cash Conversion Cycle and Operating Cycle?

Example 1: Find out the working capital cycle or cash conversion cycle and operating cycle with the help of following information:

Cost of goods sold at Rs. 2, 60,000 and opening stock of raw material is Rs. 10, 000. Company XYZ sale 40% goods on credit and the total sales is Rs. 6, 70,000. The opening and closing balance of finished goods are Rs. 40, 000 and Rs. 20, 000 respectively. Company takes 6 days to convert work in progress into finished goods. The average debtors is Rs. 45, 000 and the closing balance of accounts payable is Rs. 38, 000. The credit purchase is Rs. 2, 90,000.

Solution: average raw material = (10, 000+0)/2 

= Rs. 5, 000

 Raw material holding period = 365/cost of goods sold/average raw material

= 365/2, 60,000/5, 000 = 365/ 52

= 7 days

Average finished goods = opening finished goods +closing finished goods)/2

=(40, 000+20, 000)/2 

= 30, 000

Finished goods holding period = 365/2, 60,000/30, 000

365/8.66

= 42 days

Credit sales = 0.40*6, 70,000 = Rs. 2, 68,000

Accounts Receivable period= 365/2, 68,000/45, 000

= 365/5.95

= 61 days

Average creditors = (opening creditors + closing creditors)/2

= (0+38, 000)/2

= 19, 000

Accounts payable period = 365/credit purchase/average creditors

= 365/2, 90,000/19, 000

= 365/15.26

= 24 days

Working capital cycle or cash conversion cycle: raw material holding period + work in progress holding period + finished goods holding period + accounts receivable period - accounts payable

= 7 + 6 + 42 + 61 -24

= 92 days

Company XYZ takes 92 days to convert its raw material into cash.

Example 2: Find out the operating cycle of Company A and B and compare with cash conversion cycle with the help of given information:

Particulars	Company A’s Ratio	Company B’s Ratio
Inventory turnover ratio	8:1	17:4
Debtors turnover ratio	10:3	6:1
Creditors turnover ratio	9:2	14:3

 Inventory includes raw material,work in progress and finished goods.

Solution: Inventory holding period = 365 / inventory turnover ratio

= 365 / 8

= 46 days

Accounts Receivable period = 365 / debtors turnover ratio

= 365 / 3.33

=110 days

Accounts payable period = 365 / creditors turnover ratio

= 365 / 4.5

= 81 days

Operating cycle = Inventory holding period + Accounts receivable period

= 46 + 110

= 156 days

Company A takes 156 days to convert its inventory into credit sales to debtors.

Cash conversion cycle of company A = Operating cycle – Accounts payable period

= 156 – 81

= 75 days

 Company A takes 75 days to convert operating cycle into cash.

Inventory holding period of company B = 365 / 4.25

= 86 days

Accounts receivable period = 365 / 6

= 61 days

Accounts payable period = 365 / 4.66

= 78 days

Operating Cycle = 86 + 61

= 147 days

Cash conversion cycle = 147 – 78

= 69 days

Company B takes 147 days to convert its material into debtors and 69 days to convert its operating cycle into cash through sales.

So, The cash conversion cycle of company B has taken 6 days less than company Y which proves that company B has better liquidity in comparison to company A.