1.

INTRODUCTION

The life or death of any business enterprise depends upon the availability of cash. A business enterprise
incurring losses still survive because of sufficiency of cash. Similarly, lack of cash can give rise to failure in
the face of actual or prospective earnings.

(Efficient cash planning through a relevant and timely cash budget may enable a firm to obtain optimum
working capital and ease the strains of a cash shortage, facilitating temporary investment of cash and
proving funds for funds for normal growth.)

A lot of companies and factories are interested in increasing their profits. However, very few companies
worry about managing their working capital. A lot of companies fail due to bad management of working
capital. They may be profitable, but they are not able to pay their bill.

Management is an art of preparing for risks, uncertainties and overcoming obstacles. An essential
precondition for consistent assets management is establishing the consistent asset management policies
covering fixed as well as current assets. In modern financial management, efficient allocation off ....... as a
great scope, in finance and profit planning, for the most effective utilization of enterprise resources, the
fixed and current assets have to combined in optimum proportions.

According to Shubin, “ Working capital is the amount of funds necessary to cover the cost of operating the
enterprise.”

1.1 WORKING CAPITAL MANAGEMENTS TAKES PLACE AT TWO LEVELS

A. Ratio analysis can be used to monitor overall trends in working capital and to identify areas
requiring management.
B. The individual components of working capital can effectively managed by using various strategies.

When considering these strategies, company needs to recognize that each department has a unique mix of
working capital elements. It keeps your cash flowing as quickly as possible. The business needs to be
maintained:-

 Set the price

 Control the cost
Working capital in simple terms means the amount of funds that accompany requires for financing its
day-to-day operations. Finance managers should develop techniques of managing current assets.

1) WHAT IS THE WORKING CAPITAL ?

Working capital refers to the investment by the company in short terms assets such as cash ,
marketable securities.
Working capital = Current Assets – Current Liabilities.
Working capital management is an important financial term. It deals with the managerial accounting
strategies that monitor the current assets and liabilities. This is essential for a business to maintain an
efficient operation of the company. An effective working capital management ensures that the business
always has a sufficient cash flow to support its short term operating costs.

2) DEFINATION OF WORKING CAPITAL:-

A. Working capital is the money available to meet your current , short-term obligations.
B. To make sure your working capital works for you, you will need to calculate your current levels,
project your future needs and consider ways to make sure you always have enough cash.
C. Working capital is the difference between the inflow and outflow of funds. In other words it is
the net cash inflow.
D. Working capital is the gross working capital , it is also known as circulating capital or current
capital for current asset are rotating in their nature.
1.2 IMPORTANCE OR SIGNIFICANCE OF WORKING CAPITAL:-

A. Credit sales:- It is possible to sell goods on credit if sufficient working capital is available. As a result
of this increase in sales volume also increases the profit margin.
B. Opportunity of cash discount:- If there is sufficient working capital , it is possible to pay the dues of
suppliers of raw materials quickly. As a result , cash discount is available for them .
C. Solving the crisis:- If the business has enough working capital, it can be easily dealt with if there is a
sudden downturn in the market or if additional raw materials need to be purchased on an urgent
basis or if any temporary emergency arises. Because at that time there is more pressure on working
capital.
D. Possibility of getting loans:- Sufficient working capital indicates ease of doing business and
indicates satisfactory debt repayment capacity as all the institutions having sufficient working
capital can easily get loans from the market on favorable terms.
E. Increase in profitability:- Fast turnover and proper management of working capital leads to
prevention of wastage , increase in production and sales and opportunities for cash flow. This
increase the profitability of the business.

In the business the working capital is comparable to the blood of the human body. Therefore, the study of
working capital is of major importance to the internal and external analysis because of its close relationship
with the current day to day operations of a business. The mismanagement of working capital is the leading
cause of the business failures.

To meet the current requirements of a business enterprise such as the purchase of services, raw materials
etc. Working Capital is essential. It is also pointed out that working capital is nothing but one segment of
the capital structure of a business.
1.3 Working capital management introduction
Working capital is the key difference between the long term financial management and short term
financial management in terms of the timing of cash. It aims to ensure that a company can afford its day-
to-day operating expenses while also investing the company’s assets in the most succesful direction
possible. It represents the relationship between a firm’s short-term assets and its short-term liabilities.

Long term finance involves the cash flow over the extended period of time i.e 5 to 15 years, while short
term financial decisions involve cash flow within a year or within operating cycle.

Working capital management aims at more efficient use of a company’s resources by monitoring and
optimizing the use of cureent assets and liabilities. The goal is to maintain sufficient cash flow to meet its
short-term operating costs and short term debt obligations and maximize profitability.

It is concerned with the problems that arise in attempting to manage the current assets, the current
liabilities and the inter relationship that exists between them. The current aseets refer to those assets
which can be easily converted into cash in ordinary course of business, without disturb of the firm.

It is a business process that helps companies make effective use of their current assets and optimize cash
flow. It’s oriented around ensuring short-term financial obligations and expenses can be met, while also
contributing towards longer-term business objectives.

 COMPOSITION OF WORKING CAPITAL

Major Current Assets
A. Cah
B. Accounts receivables
C. Inventory
D. Marketable securities

Major Current Liabilities

A. Bank overdraft
B. Outstanding expenses
C. Accounts payable
D. Bills payable

The goal of capital management is to manage the firm’s current assets and liabilities. So that the
satisfactory level of working capital is maintained. If the firm can not maintain the satisfactory level of
working capital, it is likely to become insolvent and may be forced into bankruptcy. To maintain the margin
of safety current asset should be large enough to cover its current assets.

Main theme of the theory of working capital management is interaction between the current assets and
the current liabilities.
 2. CONCEPT :-
There are 2 concepts:

 Gross working capital

 Net working capital

Gross working capital:- Sum of total current assets employed in the business.

This concept is important due to the following reasons:-

A. It enables the enterprise to provide correct amount of working capital at the right time.
B. The gross concept takes into consideration the fact that every increase in the funds of the
enterprise would increase its working capital.
C. The gross concept of working capital is more useful in determination the rate of return on
investments in working capital.

GROSS WORKING CAPITAL = CURRENT ASSETS

Focuses on,

 Optimum investment in current assets:

Excessive investments impairs firm’s profitability, as idle investment earns nothing. Inadequate working
capital can threaten solvency of the firm because of its inability to meet its current obligations.
Therefore there should adequate investment in current assets.

 Financing of current assets:-

Whenever the need for working capital funds arises, agreement should be made quickly. If surplus
funds are available they should be invested in short term securities.

Net working capital (NWC) – defined by 2 ways,

Difference between current assets and current liabilities.

Net working capital is that portion of current assets which is financed with long term funds.

The net working capital concept is important due to the following reasons:-

A. It is a qualitative concept which indicates the firm’s ability to meet its operating expenses and short
term liabilities.
B. It is an indicator of the financial soundness of an enterprise.
C. It suggests the need for financing a part of the working capital requirements out of permanent
sources of funds.

NET WORKING CAPITAL = CURRENT ASSETS - CURRENT LAIBILITIES

If the working capital is efficiently managed then liquidity and profitability both will improve. They are not
components of working capital but outcome of working capital . working capital is basically related with
the question of profitability v/s liquidity and related aspects of risk.
2.1 OBJECTIVES OF WORKING CAPITAL:-
Working capital is required to run day to day business operations . firms differ in their requirement of
working capital. Firms aim is to maximize the wealth of share holders and to earn sufficient return form its
operations.

A. To enhance the profitability and financial stability of the organization.

B. What amount of effective capital investment will not disturb the profitability or liquidity position of
the institution to determine.
C. Maintain proper control over inventories , receivables and cash.
D. To estimate working capital for new projects.
E. Current assets and current liabilities to verify whether the liquidity position of the organization is at
desired level review regularly.

To optimize the investment in current assets and to reduce the level of current liabilities , so that
the company can reduce the locking up of funds in working capital and can improve the return on
capital employed in the business.
To manage the firms current assets in such a way that the marginal return on investment in these
assets is not less than the cost of capital employed to finance the current assets.

2.2 THE NEED OF WORKING CAPITAL:-

The need for working capital cannot be emphasized. Every business needs some amount of working
capital. The need for working capital arises due to time gap between production and realization of cash
from sales. Thus, the working capital is needed for the following purposes:

A. For the purchase of raw materials, components and spares.

B. To pay wages and salaries.
C. To incur day to day expenses and overhead costs such as fuel, power and office expenses etc.
D. To meet the selling costs facilities to the customers.
E. To provide credit facilities to the customers.
F. To maintain the inventories of raw material, work-in-progress, stores and spares and finished stock.

2.3 PLANNING OF WORKING CAPITAL:-

Working capital management is a significant face of financial management. It’s important from two
reasons:

Investment in current asset represents a substantial portion of total investment.

Investment in current assets and level of current liability has to be geared quickly to change in
sales.

Business undertaking required funds for two purposes:

To create productive capacity through purchase of fixed assets.

To finance current assets required for running of the business.

The importance of working capital is reflected in the fact that financial managers spend a great deal of time
in managing current assets and current liabilities.
A firm requires many years to recover initial investment in fixed assets. On contrary the investment in
current asset is turned over many times a year. Investment in such current assets is realized during the
operating cycle of the firm.

It is the time to taken to convert net assets and net liabilities into cash. There are several day-to-day
business activities which required readily available cash. A working capital cycle can be long and short
depending upon the time taken to convert into cash.

2.4 WORKING CAPITAL CYCLE FORMULA:-

The working capital cycle represents the time it takes for a company to convert its current assets (such as
inventory) into cash, and then use that cash to pay off its current liabilities (such as accounts payable). The
formula for working capital cycle is:

WORKING CAPITAL CYCLE FORMULA= INVENTORY DAYS + RECEIVABLE DAYS - PAYABLE DAYS.
2.5 National Scenario of Working Capital Management:

Optimizing Financial Efficiency:

Working capital management is a critical aspect of financial management for both businesses and nations.
It involves effectively managing current assets and liabilities to ensure smooth operations, meet short-term
obligations, and maximize financial efficiency. In this national scenario, we will explore how a fictitious
country, Zelandia, implemented strategic working capital management practices to optimize its economic
performance and strengthen its financial position.

Economic Background:

Zelandia, a developing nation, has experienced steady economic growth over the past decade. However,
inefficient working capital management has been a persistent challenge, leading to cash flow constraints
and hindering overall economic development. Recognizing the need for improvement, the government
embarked on a comprehensive working capital management initiative.

Government Intervention:

The government of Zelandia initiated various policy measures to enhance working capital management
across the country. These measures included:

1. Strengthening Financial Education: The government launched a nationwide financial literacy campaign to
educate businesses and individuals about the importance of effective working capital management.
Seminars, workshops, and online resources were made available to disseminate knowledge and best
practices.

2. Streamlining Payment Systems: To expedite the collection and disbursement of funds, the government
implemented electronic payment systems, encouraging businesses and individuals to embrace digital
transactions. This move significantly reduced transaction times and minimized the need for physical cash
handling.

3. Encouraging Collaboration: The government facilitated collaboration between financial institutions,

businesses, and suppliers to establish efficient supply chain networks. This collaboration improved
communication, reduced order processing time, and enhanced the overall liquidity of businesses.

4. Promoting Inventory Optimization: The government introduced inventory management guidelines,

encouraging businesses to adopt just-in-time (JIT) inventory practices. By optimizing inventory levels,
businesses minimized carrying costs and freed up working capital, resulting in improved cash flow.

5. Enhancing Access to Credit: The government launched initiatives to improve access to credit for small
and medium-sized enterprises (SMEs). This included establishing specialized loan programs, reducing
bureaucratic hurdles, and implementing credit guarantee schemes. Accessible credit empowered SMEs to
manage their working capital effectively and invest in growth opportunities.

6. Strengthening Fiscal Discipline: The government implemented prudent fiscal policies, aimed at reducing
budget deficits and curbing excessive borrowing. This approach helped maintain a stable macroeconomic
environment and reduced the crowding-out effect, enabling businesses to access affordable credit.
Outcomes and Benefits: The strategic implementation of these working capital management measures
yielded significant benefits for Zelandia:

1. Improved Cash Flow: By implementing efficient payment systems and inventory optimization practices,
businesses experienced enhanced cash flow, allowing them to meet their short-term obligations promptly.
This strengthened financial stability and reduced the risk of liquidity crises.

2. Increased Business Productivity: Collaboration and streamlined supply chain networks facilitated faster
order processing, reduced lead times, and improved business productivity. This led to increased customer
satisfaction, repeat business, and overall economic growth.

3. Sustainable Growth: The availability of accessible credit for SMEs encouraged entrepreneurship and
innovation, leading to the growth of new businesses and the diversification of the economy. Sustainable
growth and job creation further contributed to the economic prosperity of Zelandia.

4. Strengthened Financial Position: The government's focus on fiscal discipline resulted in reduced
borrowing costs, improved credit ratings, and increased investor confidence. This attracted foreign direct
investment, stimulating economic growth and strengthening Zelandia's overall financial position.

The national scenario of working capital management in Zelandia exemplifies the transformative impact of
strategic policies and initiatives. By adopting a comprehensive approach, encompassing financial
education, streamlined payment systems, collaboration, inventory optimization, credit access, and fiscal
discipline, the government successfully enhanced the nation's financial efficiency and stimulated
sustainable economic growth. This scenario serves as a testament to the importance of working.
2.6 The International Scenario of Working Capital Management
Enhancing Global Financial Competitiveness:

Working capital management is not only crucial at the national level but also plays a significant role in the
global economy. Effective management of working capital is essential for businesses operating in an
increasingly interconnected and competitive world. In this international scenario, we will explore how a
fictional global initiative focused on working capital management improved financial competitiveness,
facilitated cross-border trade, and fostered economic growth.

Global Initiative for Working Capital Management:

Recognizing the importance of working capital management in driving economic progress, international
organizations and governments collaborated to establish a global initiative aimed at optimizing working
capital practices across countries. Key components of this initiative included:

1. Harmonizing Standards and Regulations: Participating countries harmonized accounting standards,

reporting requirements, and regulatory frameworks related to working capital management. This
alignment promoted transparency, comparability, and consistency in financial reporting, thereby
facilitating cross-border transactions.

2. Facilitating Trade Financing: The initiative established mechanisms to enhance access to trade financing
for businesses engaged in international trade. This involved developing standardized documentation, such
as letters of credit and bank guarantees, and streamlining the process for issuing and verifying trade-
related financial instruments.

3. Leveraging Technology: Advanced technological solutions, such as block chain and digital platforms,
were implemented to improve efficiency in supply chain finance and trade processes. These technologies
enabled real-time tracking of goods, automated payment verification, and reduced transaction costs,
thereby improving overall working capital management.

4. Sharing Best Practices: The initiative created a platform for knowledge sharing and collaboration among
participating countries. Regular conferences, workshops, and online forums were organized to share best
practices, case studies, and success stories in working capital management. This exchange of information
fostered innovation and encouraged the adoption of proven strategies.

5. Encouraging Sustainable Practices: The global initiative emphasized the importance of sustainable
working capital management practices. Participating countries implemented guidelines and incentives for
businesses to adopt environmentally friendly and socially responsible practices. This included promoting
sustainable supply chain management, efficient inventory control, and responsible payment practices.

Outcomes and Benefits: The international collaboration and implementation of the working capital
management initiative yielded several positive outcomes:

1. Improved Efficiency in Cross-Border Trade: Harmonized standards and regulations streamlined cross-
border transactions, reducing administrative complexities and increasing operational efficiency. Businesses
benefited from smoother trade processes, faster payments, and reduced trade finance costs, leading to
increased competitiveness in the global market.
2. Enhanced Cash Flow and Working Capital Optimization: The adoption of technological solutions and best
practices in working capital management resulted in improved cash flow for businesses. Real-time tracking,
automated payment verification, and optimized inventory management reduced working capital
requirements, enabling businesses to allocate resources more effectively and invest in growth
opportunities.

3. Increased Access to Trade Financing: The initiative's focus on facilitating trade financing opened doors
for businesses, especially small and medium-sized enterprises (SMEs), to access affordable credit.
Standardized documentation and streamlined processes reduced the risks associated with cross-border
transactions, making it easier for businesses to secure financing for international trade.

4. Strengthened Supply Chain Networks: The implementation of sustainable practices in working capital
management fostered responsible supply chain networks. Businesses incorporated environmental and
social considerations into their operations, promoting ethical sourcing, reducing waste, and enhancing the
overall sustainability of supply chains.

5. Economic Growth and Development: The international initiative's success in enhancing working capital
management practices contributed to economic growth and development on a global scale. Improved
financial competitiveness increased trade volumes, attracted foreign direct investment, and created
employment opportunities, thereby stimulating economic prosperity across participating countries.

The international scenario of working capital management demonstrates the transformative potential of
global collaboration and standardized practices. By harmonizing standards and regulations, facilitating
trade financing, leveraging technology, sharing best practices, and encouraging sustainable practices, the
initiative improved financial competitiveness, streamlined cross-border trade.
Findings:
1. Cash Management:

Proper cash management is essential to maintain liquidity and meet short-term obligations. Companies
should establish efficient cash collection and disbursement systems, including optimizing cash flows,
monitoring cash conversion cycles, and implementing effective cash forecasting techniques. By managing
cash effectively, businesses can reduce the risk of liquidity shortages and improve their ability to seize
investment opportunities.

2. Inventory Management:

Inventory management plays a vital role in working capital management. Striking the right balance
between holding excessive inventory and facing stock outs is crucial. Companies should adopt inventory
control techniques such as just-in-time (JIT) inventory, economic order quantity (EOQ), and ABC analysis to
optimize inventory levels, reduce carrying costs, and enhance operational efficiency.

3. Accounts Receivable Management:

Effective management of accounts receivable helps companies minimize credit risk and accelerate cash
inflows. Businesses should establish clear credit policies, conduct creditworthiness assessments, and
monitor customer payment patterns. Implementing techniques like offering discounts for early payments,
invoicing promptly, and actively pursuing collections can significantly improve cash flow and reduce bad
debt expenses.

4. Accounts Payable Management:

Managing accounts payable involves optimizing payment terms and maintaining strong relationships with
suppliers. By negotiating favorable payment terms and leveraging early payment discounts, companies can
effectively manage their cash outflows while preserving supplier relationships. Efficient accounts payable
management can enhance working capital availability and contribute to better credit terms with suppliers.

5. Working Capital Financing:

Obtaining adequate financing options is essential for managing working capital requirements. Companies
can utilize various sources such as short-term loans, lines of credit, and trade credit. Careful consideration
should be given to the cost and terms of financing options to strike a balance between affordability and
availability. Additionally, businesses should regularly assess their capital structure and optimize it to align
with working capital needs.
Acknowledgment
I would like to express my sincere gratitude and appreciation to all those who have contributed to the
successful completion of the project on working capital management. The completion of this endeavor
would not have been possible without the support, guidance, and cooperation of numerous individuals and
entities.

First and foremost, I would like to thank Prof. Dr. Joydeb Saha for providing me with the opportunity to
work on assignment and their valuable guidance throughout the process. Their expertise, knowledge, and
feedback have been instrumental in shaping my understanding of the subject matter.

I am thankful to the various departments and individuals who took the time to participate in interviews
and provide their insights on working capital management. Their willingness to share their expertise and
perspectives has immensely contributed to the depth and validity of the findings.

Lastly, I would like to extend my appreciation to my friends for their unwavering support and
understanding throughout this research endeavor. Their encouragement and belief in my abilities have
been a constant source of motivation.

The successful completion of this project on working capital management would not have been possible
without the collective efforts, support, and guidance of all those mentioned above. Their contributions
have been vital in shaping the findings and recommendations. I am truly grateful for their assistance and
involvement, and I look forward to implementing the insights gained from this study to enhance our
working capital management practices.

Thank you all once again for your invaluable contributions.

Sincerely,

Aditi Saha
SUPERVISOR’S CERTIFICATE

This is to certify that ARYAN SARPARE, a student of B Com (Honours) in Accounting & Finance of KALYANI
MAHAVIDYALAYA under the UNIVERSITY OF KALYANI has worked under my supervision and guidance for
his project work and prepared a project report with the title “ STUDY ON WORKING CAPITAL
MANAGEMENT “

The project report which is submitting in his genuine and original work to the best of my knowledge.

Signature:-_________________

Name – Prof. Dr. Joydev Saha

Designation – Asst. Professor

Conclusion:
Working capital management is a critical aspect of financial management that significantly impacts the
efficiency and financial performance of organizations. It involves effectively managing the components of
working capital, such as cash, accounts receivable, inventory, and accounts payable, to ensure the smooth
operation of day-to-day activities while maintaining adequate liquidity.

Proper working capital management holds immense importance for businesses of all sizes and industries. It
enables companies to meet their short-term obligations, seize growth opportunities, optimize cash flow,
and enhance profitability. By efficiently managing working capital, organizations can strike a balance
between liquidity and profitability, ensuring the long-term sustainability of their operations.

One of the primary objectives of working capital management is to optimize the cash conversion cycle. By
reducing the time it takes to convert inventory and receivables into cash, companies can improve their
liquidity position and minimize the risk of cash shortages. This can be achieved through the adoption of
effective inventory management techniques, the implementation of just-in-time (JIT) systems, and the
establishment of robust credit and collection policies.

Furthermore, working capital management enables businesses to optimize their inventory levels. Excess
inventory ties up valuable resources and increases carrying costs, while inadequate inventory can lead to
stock outs and missed sales opportunities. Through efficient inventory management practices, such as
forecasting, demand planning, and inventory turnover analysis, organizations can strike the right balance
between maintaining sufficient stock levels and minimizing holding costs.

Negotiating favorable credit terms with suppliers is another strategy in working capital management. By
extending payment terms, companies can enhance their cash flow and working capital position. This
approach requires maintaining strong relationships with suppliers and creditors, which can lead to
improved credit terms, discounts, and increased goodwill.

Accurate forecasting of working capital requirements is crucial for effective management. Companies can
utilize various techniques, such as ratio analysis, trend analysis, and cash budgeting, to forecast their
working capital needs. By having a clear understanding of their cash inflows and outflows, businesses can
make informed decisions, proactively manage their working capital, and avoid cash shortages or excesses.

Key performance indicators (KPIs) play a vital role in evaluating the effectiveness of working capital
management practices. KPIs such as the current ratio, quick ratio, inventory turnover ratio, and days sales
outstanding (DSO) provide valuable insights into a company's liquidity position, inventory management
efficiency, and collection effectiveness. Regular monitoring of these KPIs allows organizations to identify
areas for improvement, implement corrective measures, and track progress over time.

In conclusion, working capital management is essential for organizations aiming to maximize efficiency and
financial performance. By effectively managing working capital components, implementing appropriate
strategies, and utilizing forecasting techniques, businesses can optimize their liquidity position, minimize
risks, and capitalize on growth opportunities. With proper working capital management practices in place,
companies can achieve a sustainable competitive advantage and thrive in today's dynamic business
landscape.
OPERATING CYCLE:-
Raw materials are purchased with the initial cash invested at the beginning of the business. With the help
of labour and overheads , the raw materials are transformed into finished goods. Debtors are created as a
result of the sale of these goods. Cash is created again when debts are collected from debtors. This process
continues to cycle again and again. Thus the total time required to complete one cyclic process is called
operational cycle time. So, it can be said that the time it takes for the working capital to cycle once is the
operating cycle period.

The working capital cycle refers to the length of time between the firms paying the cash for materials etc,
entering into production process/stock and the inflow of cash debtors (sales), suppose a company has
certain amount of cash it will need raw materials. Some raw materials will be available on credit but cash
will be paid out for the other part immediately. Then it has to pay labour costs and incurs factory
overheads. These three combined together will constitute work in progress. After the production cycle is
completed, work in progress will get converted into sundry debtors. Sundry debtors will be realized in cash
after the expiry of the credit period. This cash can be again used for financial raw material, work in
progress, finished goods and finally into cash again. Short term funds are required to meet the
requirements of funds during this period. This time period is dependent upon the length of time within
which the original cash gets converted into cash again. The cycle is also known as operating cycle or cash
cycle.

According to I. M. Pandey, “Operating cycle is the time duration involved in the acquisition of resources,
conversion of raw materials into work- in-process into finished goods, conversion of finished goods into
sales and collection of sales.”

The operating cycle is important because it can tell a business owner how quickly the company is able to
sell inventory. Simply put, it determines the company's efficiency.
Working capital cycle can be determined by adding the number of days required for each stage in the
cycle. For example, company holds raw material on average for 60 days, it gets credit from the supplier for
15 days, finished goods are held for 30 days and 30 days credit is extended to debtors. The total days are
120, i.e., 60-15+15+30+30 days is the total of working capital.

Thus, the working capital cycle helps in the forecast control and management of working capital. It
indicates the total time lag and the relative significance of its constituent parts. the duration may very
depending upon the business policies. In light of the facts discusses above we can broadly classify the
operating cycle of a firm into three phases viz.

1. Acquisition of resources.
2. Manufacture of the product and
3. Sales of the product ( cash / credit)

First and second phase of the operating cycle result in cash outflows, and be predicted with reliability once
the production targets and cost of inputs are known.

However, the third phase results in cash inflows which are not certain because sales and collection which
give rise to cash inflows are difficult to forecast accurately.

Operating cycle consists of the following:-

Conversion of cash into raw-materials;

Conversion of raw-material into work-in-progress;
Conversion of work-in-progress into finished stock;
Conversion of finished stock into accounts receivables through sales; and
Conversion of accounts receivable into cash

Most businesses cannot finance the operating cycle (accounts receivable days + inventory days) with
accounts payable financing alone. Consequently, working capital financing is needed. This shortfall is
typically covered by the net profits generated internally or by externally borrowed funds or by a
combination of the two.

The faster a business expands the more cash it will need for working capital and investment. The cheapest
and best sources of cash exist as working capital right within business. Good management of working
capital will generate cash which will help improve profits and reduce risks. Bear in mind that the cost of
providing credit to customers and holding stocks can represent a substantial proportion of a firm’s total
profits.

Each component of working capital (namely inventory, receivables and payables) has two dimensions Time
and Money, when it comes to managing working capital then time is money. If you can get money to move
faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of
money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will
need to borrow less money to fund working capital. Similarly, if you can negotiate improved terms with
suppliers e.g. get longer credit or an increased credit limit; you are effectively creating free finance to help
fund future sales.
In the form of an equation, the operating cycle process can be expressed as follows:

OPERATING CYCLE = R+W+F+D-C

R = Raw material storage period

W = Work-in-progress holding period

F = Finished goods storage period

D = Debtors collection period

C = Credit period availed

The firm is therefore, required to invest in current assets for smooth and uninterrupted Functioning.

RM – Raw material

CP – Conversion of period

WIP – Work-in-progress

PDP – Payables deferral period

Here, the length of GOC is the sum of ICP and RCP.

ICP is the total time needed for producing and selling the products. Hence, it is the sum total of RMCP,
WIPCP and FGCP. On the other hand, RCP is the total time required to collect the outstanding amount from
customers. Usually, firm acquires resources on credit basis. PDP is the result of such an incidence and it
represent the length of time the firm is able to defer payments on various resources purchased. The
difference between GOC and PDP is known as net operating cycle and if depreciation is excluded from the
expenses is computation of operating cycle, the NOC also represents the cash collection from sale and cash
payments for resources acquired by the firm and during such time interval over which additional funds
called working capital should be obtained in order to carry out the firms operations. In short, the working
capital position is directly proportional to the net operating cycle.

CULCULATIONS:-
On the basis of financial statement of an organization we can calculate the inventory conversion period.
Debtors / receivables conversion period and the creditors conversion period and based on such
calculations we can find out the length of the operating cycle (in days) both gross as well as net operating
cycle.

As mentioned above, on the basis of information presented in the Balance sheet and CMA statement of
National Management Development Corporation Limited , the length of gross as well as net operating
cycle is calculated as follows: