Chapter 13 • Management of working capital
Figure 13.2
The operating
cash cycles for
a manufacturing
business
The length of the operating cash cycle is the total time taken during which finance is required
from the business for normal trading operations.provide new funds in the form of cash, some shares may be redeemed for cash, and
dividends will normally be paid. Similarly, long-term lenders (existing or new) may
provide debt finance, borrowings will need to be repaid from time to time, and inter-
est obligations will have to be met. Unlike movements in the working capital items,
most of these ‘non-working-capital’ cash transactions are not everyday events. Some
of them may be annual events (for example, lease payments, dividends, interest and,
possibly, non-current asset purchases and disposals). Others (such as new equity and
debt finance and redemption of old equity and debt finance) would typically be less
common events. A factor that most of these non-working-capital transactions have in
common is their size: they are likely individually to involve large amounts of cash.
These non-working-capital transactions are shown in the lower portion of Figure 13.1.
It is obvious that the management of working capital, and particularly of cash, is
closely linked to financing decisions and to decisions involving investment in non-
current assets. This linkage involves quantities of cash, the timing of cash flows and
the level of risk involved. For example, if particular long-term borrowings are to be
redeemed under a contractual obligation, thought must be given to the question of the
source of that cash. If cash has not been generated through the working capital cycle,
some other source (for example, new equity or debt finance) will need to be consid-
ered. These themes will be developed later in this chapter.Measuring the operating cash cycle
The working capital cycle, represented descriptively in the top part of Figure 13.1, can
also be expressed in a more quantitative manner, as shown in Figure 13.2. Here
the length of time that each element of working capital takes in the cycle is shown.
Figure 13.2 also refers to a manufacturing business, but can easily be amended to fit
non-manufacturers.
In Figure 13.2, raw materials (RM) inventories are held for a period of time before
they are taken into production: the inventories now become part of the WIP, along
with other elements (labour, overheads and so on) until such time as it is completed
and forms part of finished goods (FG) inventories. Finished inventories are held until
they are sold to become trade receivables, which in due course are paid by the
customers concerned; thus the cycle is completed. The sum of the time taken from
the payment for purchase of the raw material inventories to the receipt of cash from