BUSF_A01.qxd

The dynamics of working capital

customers is known as the operating cash cycle.This cycle must be financed by the

business. Broadly, the shorter the operating cash cycle, the less finance is required.

One of the objectives of working capital management is to keep this cycle to a min-

imum length. By doing so, the shareholders’ wealth will tend to be enhanced, all other

things being equal.

The following information relates to Jittery plc for last year:

£ million

Purchases of raw materials 67

Usage of raw materials 65

Revenue from sales of finished goods (all on credit) 250

Cost of sales of finished goods 180

Average trade payables 14

Average raw materials inventories 12

Average work in progress 10

Average finished goods inventories 21

Average trade receivables 47

What is the length of the operating cash cycle?

Example 13.1

Days

RM inventories period × 365 =× 365 = 67

Production period × 365 =× 365 = 20

FG inventories period × 365 =× 365 = 43

Trade receivables settlement period × 365 =× 365 = 69

199

Trade payables settlement period × 365 =× 365 =(76)

Operating cash cycle (days) = 123

Notes to the solution

It should be noted that days in the above solution are not of equal importance in economic

terms. For example, reducing the trade receivables settlement period by one day will save

funding of £685,000 (i.e. £250 million/365). Increasing the trade payables settlement period

by one day will save funding to the extent of only £184,000 (i.e. £67 million/365). So, despite

the fact that these two actions would leave the length of the operating cash cycle

unchanged, they would have the effect of reducing the working capital investment by a net

amount of £501,000 (i.e. £685,000 – £184,000).

14

67

Trade payables

RM purchases

47

250

Trade receivables

Sales revenue

21

180

FG inventories

Cost of sales

10

180

WIP

Cost of sales

12

65

RM inventories

RM usage

Solution

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