Cash operating cycle / working capital cycles
This is the period from where the firm pays cash for raw materials to when cash is actually
received from debts. The cash operating cycle COC is made up of the following conversion
period.
Cash
Raw Materials
Debtors
Finished goods W.I.P
Raw material conversion time- (RCT)
Average time from purchase of raw material to conversion such raw materials into WIP or the
average time from purchase of raw materials to the time they enter into production cycle.
Formula RCT = Value of raw materials in stock
Raw materials consumed/ day
Work In Progress (WCT)
Work in progress conversion time - time taken to converse the W/P into finished products the
shorter the better.
WCT = Value of WIP
Cost of goods manufactured/ day
Creditors Conversion Time (CCT)
It is the time from the purchase of raw materials to the time when the firm makes actual cash
payments for raw materials (the longer the better- you can must and earn interest)
CCT = Value of creditors
Purchase of raw materials/ day
Finished goods conversion time (FCT)
Average time taken to sell goods that have come out of the production line- the less the better)
FCT = Value of finished goods
Costs of goods sold/ day
Debtors conversion time average conversion time)
The period from when goods are sold to the period when the firm receives payment from debtors
DCT = Value of trade debtors
Value of sales/ day
Formula = RCT + WCT + FCT + DCT –CCT
The CCT is deducted in calculating the cash operating cycle because the firm has not yet paid for
raw materials
Example
The introduction of ESAP has had an effect on the working capital management of the firm. The
Treasurer of Better ltd is interested in finding out whether there have been any changes in the
COC. The information has been obtained for the calculation operating cycle.
Item 2018 2019
Sales 3 240 000 3 600 000
Purchase R/M 1 125 000 1 687 000
Raw Materials consumed 1 080 000 1 440 000
Cost of goods manufactured 2 160 000 2 880 000
Debtors 540 000 800 000
Creditors 156 250 375 000
Inventory: RM 90 000 60 000
W/P 60 000 120 000
Finished Goods 25 000 75 000
Cost of Goods sold 1 800 000 2 700 000
A) Assuming a 360-day year calculate the cash operating cycle for the two years.
b) State and explain some of the reasons for the changes in the cash operating cycle.
Solution
RCT 90 000 x 360 = 30 days 60 000 x 360 =15 days
10 80 000 1 440 000
CCT 360 x 156 250 = 50 days 375000 x 360=80 days
1125 000 1 687 000
WCP 360 x 60 000 = 10 days 120000 x 360 =15days
2160000 2880000
FCT 25000 x 360 = 5days 75000 x 360 = 10days
1800000 2700000
DCT 360 X 540 000 =60days 800 000 x 360 =80days
324 000 3 600 000
Cash Operating Cycle 30 + 10 + 5 + 60 – 50 15 – 80 + 15 + 10 + 80 =
=55days 40days
Operating Cycle
It is the average number of days that it takes to turn raw materials into cash proceeds from sales.
Operating cycle =inventory conversion time + debtor conversion time
Cash conversion cycle
Is the length of time it takes to turn the firms cash investment in inventory back into cash in the
form of collections from the sales of that inventory.
Cash conversion cycle = Operating cycle – Creditors conversion time
Debtor conversion time
Is the average number of days it takes for the company’s customers to pay their bills.
= trade receivables / accounts receivables * 365 days
credit sales
Creditors conversion time
It is the average amount of time it takes the company to pay its bills.
= Accounts payables * 365 days
Purchases (trade payables)
Raw material conversion time (RCT)
= Raw materials inventory *365 days
Purchases (trade payables)
Work in progress conversion time (WCT)
= Work in progress inventory * 365 days
Cost of sales
Finished goods conversion time (FCT)
= finished goods * 365 days
Cost of sales
Inventory conversion period
= Raw material conversion time + work in progress conversion time + finished goods conversion
time
Extracts from the financial statements of XYZ Ltd are set out below;
$
Inventories:
Raw Materials 844 000
Work-In-Progress 448 128
Finished Goods 1 567 898
Trade receivables 1 425 600
Trade payables 1 745 000
Annual cost of sales 5 272 128
Annual sales 5 802 400
Accounts payable 604 800
Required;
i) Calculate the length of the Operating Cycle (OC) and the Cash Conversion Cycle
(CCC) for the company assuming a 365 day year. Round off all answers to the nearest
day. [14 marks]
INVENTORY CONVERSION PERIOD
Raw material conversion time (RCT) = (Raw materials / trade payables) *365 days
= (844 000 / 1 745 000)*365
= 177 days
Work in progress conversion time (WCT) = (Work in progress / cost of sales)*365 days
= (448 128 / 5 272 128)*365 days
= 31 days
Finished goods conversion time (FCT) = (Finished goods / cost of sales) * 365 days
= (1 567 898 / 5 727 128)*365 days
= 109 days
Inventory conversion period = RCT + WCT + FCT
= 177+ 31 + 109
= 317 days
Debtor conversion time (DCT) = (Trade receivables / sales) * 365 days
= (1 425 600 /5 802 400) *365
= 90 days
Operating Cycle = Debtor conversion time + inventory conversion time
= 90 + 317
= 407 days
Creditors conversion time = ( accounts payables / trade payables ) * 365 days
= (604 800 / 1 745 000) * 365 days
= 127 days
Cash conversion cycle = operating cycle – creditors conversion time
= 407 – 127
= 280 days
