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Corporate Finance Chapter8
Corporate Finance Chapter8
The operating cycle is the length of time it takes a companys investment in inventory to
be collected in cash from customers.
In Other Words. An operating cycle is the average time period between the acquisition of
inventory and the receipt of cash from the inventory's sale.
The net operating cycle (or the cash conversion cycle) is the length of time it takes for
a companys investment in inventory to generate cash, considering that some or all of the
inventory is purchased using credit.
The cash conversion cycle is the number of days required for a company to convert
resources to cash flows. This measure calculates the time period during which each input
dollar is committed to production and sales processes before it is converted to cash
through the accounts receivable process. The cash conversion process gives insight into
the financial stability of a company because it reflects the time period during which assets
are committed to business processes and therefore are not available to invest to achieve
even greater returns. As a result, the shorter the cash conversion cycle, the better.
The length of the companys operating and cash conversion cycles is a factor that
determines how much liquidity a company needs.
- The longer the cycle, the greater the companys need for liquidity.
1
Collect
Acquire
on Accounts
InventoryReceivable
for Cash
Sell Inventory for Credit
Operating Cycle
Acquire
Pay
Inventory
Suppliers
for
Credit
Collect
Sell
on
Inventory
Accounts
for
Receivable
Credit
9,56,35,937
5,42,79,292
2,10,66,544
2,23,18,672
72,53,989
365
Inventory conversion
period
=
=
=
Inv /(COGS/365)
142
178
Receivables
collection period
Payables deferral
period
+
+