The working capital cycle is an essential financial indicator of your business’s financial efficiency. This measures and tracks your business’s time to convert assets and liabilities into cash. In simple words, this cycle dedicates how long it takes for you to arrange finds for your business.
Knowing this is important as liquidity is a crucial parameter to carry out the regular operation of your business. Gaining more information on the capital cycle can help you maintain stability during a challenging economic environment.
Successful business management includes comparing all the current assets against current liabilities. However, there are a few important pillars to keep in mind for better management of working capital:
This indicates the time taken by the buyer to pay the seller for goods or services. The billing process includes:
This indicates the overall time a company takes to convert sales into inventory. This is an important component indicating your business’s inventory management and how well you manage the stock levels. All the money spent on buying inventory gets deducted from the working capital.
Managing the receivables is important in terms of collecting the money owed to a company. Receivables are the amount owed to your company for purchasing goods or services indicating the rights to collect in future.
You can ensure a constant and steady cash flow to the business by ensuring the timely management of payables and receivables. That can help better optimise operation efficiency, which helps in making a strategy to balance the requirements.
The time required to convert the current assets to cash is calculated by adding different operating cycle days. The working capital days indicate the time period starting from the day you pay for inventory to the payment you receive by selling.
These are the cycles involved in the procedure:
Knowing all the cycles and the days each takes, you can use the working capital cycle equation.
Also Read: What is Working Capital Demand Loan (WCDL)?
Using the formula for the working capital cycle, you can calculate the capital cycle:
Working Capital Cycle= Inventory Days + Receivable Days – Payable Days
To increase your business’s operational efficiency, you can implement various strategies such as:
This strategy can increase payable days by maintaining a good supplier relationship. You can negotiate to keep the cash for a longer period and utilise it in various other areas of your business.
You can reduce the receivable days with proper practice of maintaining invoices. You can also offer discounts for previous payments.
By improving demand forecasting and applying lean inventory techniques, you can reduce and decrease the length of inventory days.
You can also use certain software and tools to manage the capital cycle. Using inventory management software will help you to track stocks and optimise reorder points. Having a good invoicing system can help you in billing automation, eventually speeding up the payment cycle.
Using a financial planning tool can provide you with information on ongoing cash flow trends. This will help in better financial strategizing and business forecasting.
By using these techniques, you can effectively optimise your capital cycle to create sustainable financial health in the long term. While it is necessary to maintain the capital cycle, sometimes unforeseen expenditures can cause financial scarcity.
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A short capital cycle is desirable, though having a long cycle is not bad. However, it depends on the nature of the business.
The cycle represents the availability of liquidity and, hence company’s cash flow. The shorter it is, the better the business can run.
Yes, a negative capital cycle represents the availability of liquidity to carry out day-to-day business expenses, benefiting the company.
A negative working capital cycle represents a financially healthy cash flow, maintaining a positive impact on the financial statement.
