Cash cycle

Cash cycle
See also
Evergreen Loan Packing credit Interim financing Borrowing cost Customer deposits Liquidity management Quick assets Non current liability Cash Budget

Cash cycle is the circulation of cash in the life cycle of the enterprise. The purpose of money circulation is to bring profit. This period is used to calculate the cash turnover and the annual minimum cash needs.

Cash cycle period

The cash cycle determines how long money is in circulation before it makes a profit. This knowledge is very important, because the longer the cash stays in such circulation, the less money the company can spend on other needs such as:

• the purchase of fixed assets,
• operating costs,
• replenishment of inventories that were previously sold.

Often in such cycles, there are delays due to late payments from receipts. Such a situation may disrupt the proper circulation of cash in the enterprise. In this situation, the company may incur additional costs for late payments, as it will be forced to use other sources of financing to meet the terms. An example of an additional source of financing is working capital loans. Cash cycles can vary considerably depending on the type of business. Some of them may last for several days, while others may even last for several years.

Network optimalization

For the cash cycle to be profitable, the entire network must be optimized. This means that there cannot be too much stock of raw materials in warehouses, the working time between the departments must be aligned and the production size must be adapted to the market demand so that the finished product does not remain in the warehouse. Then the network of suppliers must be logically arranged so that the product or good is delivered to the right location at the right time and the cash returns to the company as soon as possible and begins its cycle back.

Calculating the time required to pay debts

To calculate how much time a company needs to pay its liabilities, we can divide funds in banks and transferable securities less debt within one year divided by expenses per day (total operating costs divided by 365).

${\text{cash in banks and transferable securities less debt ÷ expenses per day = the time the company needs to pay its debt}}$

For example: $7500÷$1636=4,6 days- the time the company needs to pay its debt.

Money circulation in the production plant

In a production enterprise, the cash cycle begins with the purchase of raw materials, which are then processed in the production process. The finished product is sold and the money returns to the company. In this situation, the whole process can last from several hours up to several months and even years. Before the product goes on sale, you need to calculate in order: the cost of materials used for production, the cost of production (salary and insurance of employees, maintenance of the production plant), margin (which is any percentage of the total costs). A growing enterprise is trying to quickly change materials into cash to earn and be able to buy more materials. Each sale from which we make a profit requires a small investment in business development.

Example

The length of the cash cycle usually depends on the industry in which the company operates. Restaurants have a very short cycle because food for short shelf life and customers pay for the finished dish or product in cash. A construction company can have a very long operating cycle because it has a high level of work in progress.

References

• Rachlin R. (1997), Return on investment manual: tools and aplications for managing financial results, M.E. Sharpe, USA
• Robinson T. (ed.)(2015), International financial statement analysis, John Wiley & Sons, USA
• Walker W. (2016), Supply chain architecture: a blueprint for networking the flow of material, information and cash, CRC press, USA
• ACCA F9 financial management(2015), BPP learning media, United Kingdom

Footnotes

Author: Izabela Szmalec