PROFESSIONAL PRACTICES

(HU 2×1)

LECTURE # 11
MUHAMMAD ASAD

INSTRUCTOR
DEPARTMENT OF COMPUTER SCIENCE
Key Learning Point :-

- Explain the concept of working capital cycle

 WORKING CAPITAL CYCLE
There are three main steps in the working capital cycle…
1: Pay for assets (inventory to sell or equipment for a job).
2: Sell inventory (complete the job for a customer).
3: Receive payment on what you’ve sold (funds now available to pay costs).

 The longer the working capital cycle is --- The more time it takes for your
business to get a good cash flow --- It’s common for businesses to manage
their cycle by revising each step where possible --- This could be by selling
inventory quicker, collecting payment sooner, and paying bills later on.
WHAT AFFECTS THE WORKING CAPITAL CYCLE?

 Factors will vary between industries, but essentially --- How long it takes you
to sell your inventory and how long it is before you receive payment will
impact the length of the working capital cycle for your business.

FOR EXAMPLE

A manufacturing company purchases raw materials on credit (pay after 60 days)

from their supplier for a product which they expect to sell in eight weeks’ time to a
client.
Payment from the client, may not come immediately (received after 30 days).
The manufacturer still needs to pay the supplier before their credit payment
terms of 60 days are up.
WORKING CAPITAL CYCLE FORMULA
To calculate the working capital cycle…
Inventory Days — How long it takes to sell the inventory
PLUS
Receivable Days — How it takes to receive payment from customer
MINUS
Payable Days — How long you have to pay your supplier

Working Capital Cycle = Inventory Days + Receivable Days – Payable Days

POSITIVE CYCLE VS NEGATIVE CYCLE

It’s normal for most businesses to have a positive working capital cycle ---
Have a number of days where they are waiting for payment to give them
available cash.

A business with a negative cycle has collected money at a faster rate than they
need to pay off their bills, which means the end number after using the formula
is a minus number.
Calculate the working capital cycle for the manufacturer ABC Ltd. Suppose
ABC Ltd. has 56 Inventory Days, 30 Receivable Days and 60 Payable Days.

Working Capital Cycle = Inventory Days + Receivable Days – Payable Days

= 56 + 30 - 60
The working capital cycle for the ABC Ltd. is 26 days. (a positive cycle)

 This number indicates --- How many days the business is out of pocket ---
before receiving full payment.
Calculate the working capital cycle for the manufacturer XYZ Ltd. Suppose
XYZ Ltd. has 25 Inventory Days, 20 Receivable Days and 60 Payable Days.

Working Capital Cycle = Inventory Days + Receivable Days – Payable Days

= 25 + 20 - 60
The working capital cycle for the ABC Ltd. is -15 days. (a negative cycle)

 Many businesses struggle for a negative working capital cycle by trying to

move inventory at a faster rate, shortening customer payment terms and
lengthening their own payment terms.
IMPROVE THE WORKING CAPITAL CYCLE

 They’re simple, reduce inventory days, reduce receivable days, and

increase payable days.

1: Invoice management could be the key, to reduce your receivable days.

Shorten your invoice terms, offer early-bird discounts, and improve your
credit collection process. A popular method for invoice management is to use
invoice finance to bring forward the revenue you’re due within a few days of
the invoice being raised.
2: Your inventory sold as soon as you can and shorten the length of time you
have it on hand --- This will help you avoid storing and could even save you
some money on storage costs.

3. Debatably the most difficult step of the cycle to change is the payable
days. Ideally, try and lengthen them, possibly by negotiating credit terms with
your suppliers --- There is also the option to seek alternative funding --- Like
a business credit card to pay your costs but it’s incredibly important to be
aware of extra costs this might involve, and thus impact your working capital
cycle in a way you aren’t aiming for.
 ANY QUESTION

You can contact me at: asadali@uosahiwal.edu.pk

Your query will be answered within one working day.