Question

An accountant has calculated the following ratios for his company for the last three years.

(Remember: To convert turnovers into time periods, divide 365 days by the turnover.)

	2018	2019	2020
Accounts receivable turnover	7	8	9
Inventory turnover	3	3.5	4
Accounts payable turnover	4	3.5	3

Required:

i) Calculate the Operating Cash Cycle time for each of the three years.

ii) Comment on the significance of the Operating Cash Cycle for the management

Answer 1

(i): Operating cash cycle = inventory holding period + receivable collection period - creditor's payment period

We are provided with the turnover ratios and we het the period as: period = 365/turnover

	2018	2019	2020
Accounts receivable turnover	7.00	8.00	9.00
Receivable collection period = 365/AR turnover	52.14	45.63	40.56
Inventory turnover	3.00	3.50	4.00
Inventory holding period = 365/Inventory turnover	121.67	104.29	91.25
Accounts payable turnover	4.00	3.50	3.00
Creditor's payment period = 365/AP turnover	91.25	104.29	121.67

Thus operating cash cycle for 2018 = 52.14 + 121.67 - 91.25

= 82.56 days

For 2019: 45.63 + 104.29 - 104.29

= 45.63 days

For 2020: 40.56+91.25-121.67

= 10.14 days

	2018	2019	2020
Operating cash cycle	82.56	45.63	10.14

(ii):

The significance of the Operating Cash Cycle for the management is that it helps them to guide their investment in working capital which is mainly influenced by four key events which are purchase of raw materials (which gives rise to accounts payable and inventory), payment for raw materials (which reduces accounts payable), sale of finished goods (which gives rise to accounts receivables and decline in inventory of finished goods) and collection of cash for sales.

From the numbers we can see that for the company its operating cash cycle has been declining on a year-on-year basis since 2018. This means improving working capital situation for the company. Thus the company took 82.56 days (or 2.75 months) to collect payment from its customers from the time it pays its inventory purchases. This declined to 45.63 days (or 1.52 months) in 2019 and even further to 10.14 days (or 0.34 days) in 2020. The reducing numbers show improving working capital scenario for the company.