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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.


Comments

  1. Justin DrewMarch 21, 2019 12:57 pm

    Thanks for ahsring this awesome tips with us. I hope this is very helpful to know more about the working capital in details and also for more advance information on it, then full information is here.
    https://shorttermcredits.com/working-capital.php

    ReplyDelete

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