What is a Cash Cycle?

The cash cycle is also called the cash cycle cycle, which refers to the average time required for an enterprise to pay cash to receive cash in its operations. Changes in the cash cycle will directly affect the amount of working capital required.

Cash cycle

Cash cycle period = inventory conversion period + accounts receivable conversion period-accounts payable deferred period = production

Generally speaking, the longer the inventory turnover period and the accounts receivable turnover period, the shorter the accounts payable turnover period, and the larger the working capital amount; on the contrary, the shorter the inventory turnover period and the accounts receivable turnover period, the shorter the accounts payable. The longer the turnover period, the smaller the amount of working capital. In addition, the amount of working capital turnover is also constrained by factors such as debt service risk, income requirements, and cost constraints.

Since the working capital is used for operational turnover, there should be a cycle. The length of the cycle is related to the cost of funds and the efficiency of use.

Suppose there is a company that produces personal computers, with a predicted market demand of 100 units. The following steps determine its future cash flow and show the impact of its production decisions on the company's liquidity position:

I. The company orders the components required for the production of 100 computers. Because the computer industry is accustomed to credit purchases for raw materials and parts, this transaction only has accounts payable, which has no immediate impact on cash flow;

2. Assembling parts into computer products requires the employment of some labor. When the product is completed, the wages are not fully paid, so part of the wages payable;

3. The finished computer products were sold by credit sales, so accounts receivable occurred, and there was no immediate cash inflow;

4. At a certain stage in the production process, before receiving the receivables, the company must pay the payables and payable wages, resulting in a net cash outflow. This cash outflow must be borrowed from banks;

5. When the company collects and responds to the collection of accounts, the cash flow cycle of working capital has been completed. At this time, the company has the ability to repay the loan. The purpose of this loan is to assist in the production and operating turnover.

The process of computer company's production and sales activities, which converts components and labor into cash, is called the cash conversion cycle. This model uses a number of terms, which are explained as follows:

Inventory conversion period: refers to the time required to manufacture the original materials or components as a product and sell the product; sales / inventory = inventory turnover rate, the more the number of inventory turnover, it represents the company's ability to sell goods and operations The better the performance, the longer the inventory conversion period should not be.

Accounts receivable conversion period: It refers to the time required for accounts receivable to recover cash, also known as days sales outstanding (DSO).

Sales / accounts receivable = accounts receivable turnover rate. The higher the accounts receivable turnover rate, the better the speed and efficiency of the enterprise's collection. Assume that the DSO is 54 days, which means that the receivables incurred from sales are converted into cash, which takes 54 days.

The inventory conversion period and the accounts receivable conversion period are collectively referred to as the business cycle.

Accounts payable deferred period refers to the average number of days from the purchase of raw materials or the employment of labor to the payment of prices and wages. The deferment period for the general company to pay the purchase price and wages is usually 30 days.

The cash cycle includes the above three periods, and its length is equal to the number of days from the date the company purchases (resources required for production) raw materials and manual payment of cash to the date when the product is sold to recover the price, which can measure the company's cash freeze. The length of time on current assets.

The cash cycle can be calculated using the following formula:

Inventory conversion period + accounts receivable conversion period-accounts payable deferred period = cash cycle

From another perspective:

Deferred days of cash recovery-Deferred days of cash expenditure = Net deferred days

The company's management and financial management personnel should have a correct understanding of the cash cycle, because the length of the turnover period is related to the length of the freezing period of the funds, and affects the cost of funds and the efficiency of use. Financial management personnel should study possible ways to shorten the cycle to improve the efficiency of capital utilization and operating income.

Therefore, shortening the inventory turnover period and accounts receivable turnover period and extending the accounts payable payment period are the basic ways to shorten the cash cycle. Enterprises can compress the collection process and optimize the loan payment process based on their own actual conditions, such as using cash balances, concentration of payment accounts, rollover payments, establishment of zero-balance accounts, and long-distance payments. The time of loan payment accelerates the turnover of cash flow, and accordingly improves the utilization effect of cash, thereby increasing the profit of the enterprise.