Working Capital Cycle

Working Capital Cycle:

The time taken between making payment for goods taken into the business and the receipts of cash from the customers for the sale of the goods. The shorter the time between the business laying out the cash for the purchase of goods and the collection of the cash for the sale of the goods, the better for the business.

The cycle is calculated by adding the rate of inventory turnover (in days) to the trade receivables payment (collection) period (in days), and deducting the trade payables payment period (in days).

Worked example
The following is an extract from the income statement of Sandra Neal for the year ended 31 May 20*9:
  

 

£

£

Sales

 

970 365

Less cost of sales

   

 Inventory 1 June 20*8 

40 132

 

 Purchases 

437 561

 
 

477 693

 

 Inventory 31 May 20*9 

42 462

435 231

Gross profit

 

535 134

Additional information:

   

All purchases and sales are on credit.

   

Trade receivables at 31 May 20*9

76 438

 

Trade payables at 31 May 20*9

36 281

 

  
Required :
Calculate Sandra Neal’s working capital cycle.

Solution:
inventory turnover in days                            35      working capital cycle

trade receivables’ collection period in days     29      working capital cycle
                                                                64     
trade payables’ payment period in days        31      working capital cycle
working capital cycle in days                        33     

The shorter the cycle, the lower the value of working capital to be financed by other sources. The cycle can be reduced by:
•    increasing the rate of inventory turnover by reducing the levels of goods held
•    speeding up the rate at which trade receivables pay
•    taking longer to pay trade payables

02/12/2020

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