Enterprise proprietors sometimes notice with surprise that their business actually requires investing more money that they have pre-counted before. There are a lot of keys to solve this problem and one of them is the analysis of cash and operating cycles.
Since operations with cash can be divided into two major groups, cash receipt and cash payment, there can be outlined two types of cycles: a cash cycle is the time gap between the moment the payment is done and the moment when the object of this investment returns to the investor, and vice versa, an operating cycle is the time difference between the purchase is done and cash for this purchase is received.
Analysing cash cycles is very important step in improving the enterprise`s financial position, the increase of a cash or operating cycle duration may cause general worsening of the firm`s condition and may require bigger investments, and controversially the reduction of a cash or operating cycle may free up finance that could be used on other spheres. There could also be a situation when the firm is highly profitable but its finances are absorbed into cash cycles. To avoid these situations, there should be made detailed analysis of the cycles and the stages of the cycles.
One can outline about 3 locations for both cycles where money can be locked up within the cycle:
1. Customers` accounts;
2. Used for personnel operating;
3. Purveyors` accounts.
There are also 3 major time gaps that constitute the cycle:
1. Time used for mailing
2. Time used on bank operations
3. Time on processing transactions.
A useful instrument of analysis for cycles can be graphic method and calculation of cash and operating cycle period. Based on the previous facts, certain estimations for cycle duration can be made: the whole duration of cash cycle, for example, consists of three components:
1. Inventory component: its length is estimated by the age of the inventory divided by cost of sold production; in case we need to find out the duration of the period in days, this index has to be multiplied to 365; the same refers the below-mentioned components;
2. Accounts being at receipt component: its duration is measured by accounts at receipt divided by sales amount;
3. Accounts being at payment component: its duration is measured by accounts at receipt divided by total cost of sold production;
The company`s aim is to minimize the duration of the cash cycle and as ideal variant to convert positive cash and operating cycles to negative cycles, i.e. using the suppliers` and customers` financial reserves from their cash/operating cycles to make profit for the firm.
Conclusion: since cash is the most liquid asset and in many situations the most important one, the amount of finance in circulation could be significantly lessened by analysing and minimizing the cash and operating cycles of the company; it is one of important steps of the company`s successful financial management.
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