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OC and CCC - Asynchronous
OC and CCC - Asynchronous
OC and CCC - Asynchronous
1. Using your answer sheet, draw operating cycles of any two entities
following such as sari-sari store, and grocery store:
2. Create number of days in every component of each operating
cycle.
3. Finally, create insights by comparing the two operating cycles that
you prepared. Be guided by the following questions presented in
the next slide.
Questions:
1. When does the operating cycle starts?
2. When does the operating cycle end?
3. Does operating cycle varies widely by industry?
4. Which one is longer/shorter? Why?
OPERATING CYCLE
• The operating cycle measures the time period that elapsed from the date that
an item of inventory is purchased until the firm collects the cash from its sale.
If an item is sold on credit, this date is when the accounts receivable is
collected.
• Operating cycles vary widely by industry.
• Operating cycle influences a company’s need for an internal or external
financing.
OPERATING AND CASH CONVERSION CYCLES
• Operating and cash conversion cycles indicate how effectively a firm has
managed its working capital
• The shorter these two cycles are, the more efficient is the firm’s working
capital management.
MEASURING THE OPERATING CYCLE
Accounts Receivable
Average Collection Period =
Daily Credit Sales
MEASURING THE OPERATING CYCLE
• The inventory conversion period measures the number of days it takes the
firm to convert its inventory to credit sales (i.e. accounts receivable).
• The second half of the operating cycle is the number of takes it takes to
convert accounts receivable to cash (or average collection period).
• The elapsed time between the points at which a firm pays for raw materials
and at which it receives payment for finished goods.
• When the firm is able to purchase items of inventory on credit, cash is not
tied up for the full length of its operating cycle. This is known as the accounts
payable deferral period.
365
Accounts Payable Deferral Period =
(Cost of Goods Sold / Accounts Payable)
• Cash conversion cycle is shorter than the operating cycle as the firm does not
have to pay for the items in its inventory for a period equal to the length of
the account payable deferral period.
ILLUSTRATION
TRY THIS!
Illustrative Problem A:
Annual Credit Sales = 15 million
Cost of Goods Sold = 12 million
Inventory = 3 million
Accounts Receivable = 3.6 million
Accounts Payable = 2 million
Required:
Compute for the Operating Cycle and Cash Conversion
Cycle
GOT IT?
SHOW YOUR SOLUTIONS ON YOUR ANSWER SHEET.
• A negative CCC is desirable which means that these firms effectively received
cash inflows ahead of having to make the cash outflow needed to generate
those inflows.
• A positive CCC but relatively short CCC reflects a very effective current
account management.
Illustrative Problem B
Financial information for the Dell Computer Corporation (DELL) and Ford Motor
Company (F) are found below:
Compute the operating cycle and cash conversion cycle for each of these
companies. You may assume for purposes of your analysis that all of the firm
sales are credit sales. Provide the following: 1. ICP, 2. ACP, 3. PDP, 4. OC, 5. CCC
SHORTENING THE CASH CONVERSION CYCLE
1. Turn over inventory as quickly as possible without stock outs that result in
lost sales.
2. Collect account receivable as quickly as possible without losing sales from
high-pressure collection techniques.
3. Pay accounts as slowly as possible without damaging the firm’s credit rating.
4. Manage mail, processing, and clearing time to reduce them when collecting
from customers and increase them when paying vendors.
ACTIVITY 2 (PRACTICE)
Answer Exercise 1 and 2 from your handouts. Write your solutions together with
your answers.
REMEDIES THAT MAY BE ADOPTED TO REDUCE THE
LENGTH OF OPERATING CYCLE PERIOD
1. Production Management
There should be proper production planning and coordination at all levels of
activity. Also, a continuing assessment of the manufacturing cycle, proper
maintenance of plant, equipment and infrastructure facilities and improvement
of manufacturing system, technology would help shorten manufacturing cycle
thus shortening the operating cycle.
REMEDIES THAT MAY BE ADOPTED TO REDUCE THE
LENGTH OF OPERATING CYCLE PERIOD
2. Purchasing Management
The purchasing manager should ensure the availability of the right type,
quantity and quality of materials/merchandise obtained at the right price, time
and place through proper logistics management. Further, efforts exerted
towards lengthening the credit period of the suppliers, increasing the rates of
trade discount and cash discount would certainly bring favorable outcome to the
company’s deferral payment period.
REMEDIES THAT MAY BE ADOPTED TO REDUCE THE
LENGTH OF OPERATING CYCLE PERIOD
3. Marketing Management
The sale and production policies should be synchronized. Production of
quality products at lower costs enhances their marketability and saleability.
Storage costs would likewise be minimized. The marketing people should strive
to continually develop effective advertisement, sales promotion activities,
effective salesmanship and appropriate distribution channels.
REMEDIES THAT MAY BE ADOPTED TO REDUCE THE
LENGTH OF OPERATING CYCLE PERIOD
5. External Environment
The length of operating cycle is equally influenced by external environment.
The financial manager should be aware and sensitive to fluctuations in demand,
entrants of new competitors, government fiscal and monetary policies, price
fluctuations, etc. to be able to anticipate and minimize any adverse impact of
the changes to the company.
ACTIVITY 3 (APPLICATION)
1. List other five (5) remedies that may be adopted to reduce the
length of operating cycle or you may use examples from the previous
listed remedies.
“Operating cycle generally indicates how effectively a firm has managed its
working capital thru its ICP which indicates inventory management; ACP,
accounts receivable management; PDP, short-term financing management; and
CCC, cash management, which are the concerns of working capital
management.”
EVALUATION (QUIZ)