You are on page 1of 4

# Operarting cycle of a company

## Working capital is money available to a company for day-to-day operations.

The formula for working capital is:
Current Assets - Current Liabilities
How it works/Example:
Here is some balance sheet information about XYZ Company:

Using the working capital formula and the information above from Figure 1, we can calculate that
XYZ Company's working capital is:
\$160,000 - \$65,000 = \$95,000
Working capital is a common measure of a company's liquidity, efficiency, and overall health.
Because it includes cash, inventory, accounts receivable, accounts payable, the portion
of debt due within oneyear, and other short-term accounts, a company's working capital reflects
the results of a host of company activities, including inventory management, debt
management, revenue collection, and payments to suppliers.

Positive working capital generally indicates that a company is able to pay off its short-term
liabilities almost immediately. Negative working capital generally indicates a company is unable
to do so. This is why analysts are sensitive to decreases in working capital; they suggest a
company is becoming overleveraged, is struggling to maintain or grow sales, is paying bills too
quickly, or is collecting receivables too slowly. Increases in working capital, on the other hand,
suggest the opposite. There are several ways to evaluate a company's working capital further,
including calculating the inventory-turnover ratio, the receivables ratio, days payable, the current
ratio, and the quick ratio.

One of the most significant uses of working capital is inventory. The longer inventory sits on the
shelf or in the warehouse, the longer the company's working capital is tied up.The definition of

## Operarting cycle of a company

When not managed carefully, businesses can grow themselves out of cash by needing more
working capital to fulfill expansion plans than they can generate in their current state. This usually
occurs when a company has used cash to pay for everything, rather than seeking financing that
would smooth out the payments and make cash available for other uses. As a result, working
capital shortages cause many businesses to fail even though they may actually turn a profit. The
most efficient companies invest wisely to avoid these situations.

Analysts commonly point out that the level and timing of a company's cash flows are what really
determine whether a company is able to pay its liabilities when due. The working-capital formula
assumes that a company really would liquidate its current assets to pay current liabilities, which
is not always realistic considering some cash is always needed to meet payroll obligations and
maintain operations. Further, the working-capital formula assumes that accounts receivable are
readily available for collection, which may not be the case for many companies.

It is also important to understand that the timing of asset purchases, payment and collection
policies, the likelihood that a company will write off some past-due receivables, and even capitalraising efforts can generate different working capital needs for similar companies. Equally
important is that working capital needs vary from industry to industry, especially considering how
different industries depend on expensive equipment, use different revenue accounting methods,
and approach other industry-specific matters. Finding ways to smooth out cash payments in
order to keep working capital stable is particularly difficult for manufacturers and other companies
that require a lot of up-front costs. For these reasons, comparison of working capital is generally
most meaningful among companies within the same industry, and the definition of a "high" or
"low" ratio should be made within this context.

## Working capital cycle

Definition
The working capital cycle (WCC) is the amount of time it takes to turn the net current assets and
current liabilities into cash. The longer the cycle is, the longer a business is tying up capital in its
working capital without earning a return on it. Therefore, companies strive to reduce their working
capital cycle by collecting receivables quicker or sometimes stretching accounts payable.

Meaning
A positive working capital cycle balances incoming and outgoing payments to minimize net
working capital and maximize free cash flow. For example, a company that pays its suppliers in
30 days but takes 60 days to collect its receivables has a working capital cycle of 30 days. This

## Operarting cycle of a company

30 day cycle usually needs to be funded through a bank operating line, and the interest on this
financing is a carrying cost that reduces the company's profitability. Growing businesses require
cash, and being able to free up cash by shortening the working capital cycle is the most
inexpensive way to grow. Sophisticated buyers review closely a target's working capital cycle
because it provides them with an idea of the management's effectiveness at managing their
balance sheet and generating free cash flow.
Objective
1 To study the implementation of working capital.
Nature of Working Capita
Working capital management is concerned with the problems that arise in attempting to manage
the current assets, the current liabilities and the interrelations that exist between them.
Current assets refer to those assets which in the ordinary course of business can be, or will be,
converted into cash within one year without undergoing a diminution in value and without
disrupting the operations of the firm. Examples- cash, marketable securities, accounts receivable
and inventory.
Current liabilities are those liabilities which are intended, at their inception, to be paid in the
ordinary course of business, within a year, out of the current assets or the earnings of the
concern. Examples- accounts payable, bills payable, bank overdraft and outstanding expenses.

## Objective of Working Capital Management

The goal of working capital management is to manage the firms current assets and liabilities in
such a way that a satisfactory level of working capital is maintained.
The interaction between current assets and current liabilities is, therefore the main theme of the
theory of the working capital management.

Determining Financing-mix
There are two sources from which funds can be raised for current assets financing-o Short term
sources, like current liabilities and,o long term sources, such as share capital, long term
borrowings, internally generated resources like retained earnings, etc.

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.