OPERATING CYCLE APPROACH: According to this approach, the requirements of working capital depend upon the operating cycle

of the business. The operating cycle begins with the acquisition of raw materials and ends with the collection of receivables

It may be broadly classified into the following four stages viz. 1. Raw materials and stores storage stage. 2. Work-in-progress stage. 3. Finished goods inventory stage. 4. Receivables collection stage. The duration of the operating cycle for the purpose of estimating working capital requirements is equivalent to the sum of the durations of each of these stages less the credit period allowed by the suppliers of the firm. Symbolically the duration of the working capital cycle can be put as follows: O=R+W+F+D-C

Where,
O=Duration of operating cycle; R=Raw materials and stores storage period; W=Work-in-progress period; F=Finished stock storage period; D=Debtors collection period; C=Creditors payment period.

Each of the components of the operating cycle can be calculated as follows:R= Average stock of raw materials and stores Average raw materials and stores consumptions per day W=Average work-in-progress inventory

Average cost of production per day D=Average book debts Average credit sales per day C=Average trade creditors Average credit purchases per day
After computing the period of one operating cycle, the total number of operating cycles that can be computed during a year can be computed by dividing 365 days with number of operating days in a cycle. The total expenditure in the year when year when divided by the number of operating cycles in a year will give the average amount of the working capital requirement.

Techniques of inventory management

Effective inventory requires an effective control over inventories. Inventory control refers to a system which ensures supply of required quantity and quality of inventories at the required time and the same time prevent unnecessary investment in inventories.

The techniques of inventory control/ management are as follows: 1. Determination of Economic Order Quantity (EOQ)
Determination of the quantity for which the order should be placed is one of the important problems concerned with efficient inventory management. Economic Order Quantity refers to the size of the order, which gives maximum economy in purchasing any item of raw material or finished product. It is fixed mainly taking into account the following costs.

(i) Ordering costs:

It is the cost of placing an order and securing the supplies. It varies from time to time depending upon the number of orders placed and the number of items ordered. The more frequently the orders are placed, and fewer the quantities purchased on each order, the greater will be the ordering costs and vice versa.

(ii) Inventory carrying cost:

It is the cost of keeping items in stock. It includes interest on investment, obsolescence losses, store-keeping cost, insurance premium, etc. The larger the value of inventory, the higher will be the inventory carrying cost and vice versa. The former cost may be referred as the cost of acquiring while the latter as the cost of holding inventory. The cost of acquiring decreases while the cost of holding increases with every increase in the quantity of purchase lot. A balance is, therefore, struck between the two opposing factors and the economic ordering quantity is determined at a level for which aggregate of two costs is the minimum.

Formula: Q= 2U x S Where, Q = Economic Ordering Quantity U = Quantity (units) purchased in a year (month) P = Cost of placing an order S = Annual (monthly) cost of storage of one unit.
2. Determination of optimum production quantity The EOQ model can be extended to production runs to determine the optimum production quantity. The two costs involved in this process are: (i) (ii) Set up costs; Inventory carrying cost.

The set up cost is of the nature of fixed cost and is to be incurred at the time of commencement of each production run. Larger the size of the production run, lower will be the set-up cost per unit. However, the carrying cost will increase with increase in the size of the production run. Thus, there is an inverse relationship between the set-up cost and inventory carrying cost. The optimum production size is at that level where the total of the set-up cost and the inventory carrying cost is the minimum. In other words, at this level the two costs will be equal.

The formula for EOQ can also be used for determining the optimum production quantity as given below:

E=

2U x P

S Where E = Optimum production quantity U = Annual (monthly) output P = Set-up cost for each production run S = Cost of carrying inventory per annum (per month)