The cash cycle, also known as the operating cycle or cash conversion cycle, is a financial metric that measures the time it takes for a company to convert its investments in inventory and other resources into cash flow from sales. It provides insight into the efficiency of a company's working capital management.
The cash cycle can be calculated using the following formula:
Cash Cycle = Inventory Conversion Period + Receivables Conversion Period - Payables Conversion Period
1. Inventory Conversion Period (ICP):
ICP measures the average number of days it takes for the company to convert its raw materials into finished goods. It is calculated as:
ICP = (Average Inventory / Cost of Goods Sold) x Number of Days in a Year
Average Inventory = (Opening Inventory + Closing Inventory) / 2
Cost of Goods Sold = Total Sales - Closing Inventory
2. Receivables Conversion Period (RCP):
RCP measures the average number of days it takes for the company to collect payment from its customers. It is calculated as:
RCP = (Average Receivables / Total Sales) x Number of Days in a Year
Average Receivables = (Opening Receivables + Closing Receivables) / 2
Opening Receivables = Total Sales x Percentage of Sales on Credit
Closing Receivables = Total Sales x Percentage of Sales on Credit - Collections
3. Payables Conversion Period (PCP):
PCP measures the average number of days it takes for the company to pay its suppliers. It is calculated as:
PCP = (Average Payables / Total Purchases) x Number of Days in a Year
Average Payables = (Opening Payables + Closing Payables) / 2
Opening Payables = Total Purchases x Percentage of Purchases on Credit
Closing Payables = Total Purchases x Percentage of Purchases on Credit - Payments
Now, let's calculate the cash cycle using the provided information:
Given data:
Opening balances:
Raw material: ₹1,00,000
WIP: ₹45,000
Finished goods: ₹1,35,000
Debtors: ₹6,00,000
Creditors: ₹8,60,000
Closing balances:
Raw material: ₹2,00,000
WIP: ₹65,000
Finished goods: ₹1,25,000
Debtors: ₹5,45,000
Creditors: ₹9,75,000
Costs incurred during the year:
Manufacturing costs: ₹11,60,000
Excise duty: ₹18,80,000
Selling and distribution expenses: ₹6,20,000
Admin. overheads: ₹2,00,000
Total sales: ₹2,01,96,800
Total purchases: ₹1,46,00,000
Percentage of sales on credit: 40%
Percentage of purchases on credit: 70%
1. Calculate the Inventory Conversion Period (ICP):
Average Inventory = (Opening Inventory + Closing Inventory) / 2
Opening Inventory = Raw Material + WIP + Finished Goods
Closing Inventory = Raw Material + WIP + Finished Goods
Opening Inventory = ₹1,00,000 + ₹45,000 + ₹1,35,000 = ₹2,80,000
Closing Inventory = ₹2,00,000 + ₹65,000 + ₹1,25,000 = ₹3,90,000
Average Inventory = (₹2,80,000 + ₹3,90,000) / 2 = ₹3,35,000
Cost of Goods Sold = Total Sales - Closing Inventory
Cost of Goods Sold = ₹2,01,96,800 -