Working Capital Cycle

The working capital cycle is mostly used by investors or stakeholder in a given business entity to indicate the duration taken between the time a given amount of capital is invested into the said business and the time taken for the capital starts to earn the necessary interests due. In the manufacturing industry, the cycle does not begin when the finished product has been manufactured but dates back to the time the investor acquired the premises and hired the required human personnel. The working capital cycle is usually represented in a diagrammatical format to give a vivid depiction of the actual time taken between making an investment and receiving payment for the sale of the product-invested in. a good and efficient working capital cycle is considered one that balances the cash inflows with the cash outflows. This means that it gives clear information on whether an investor is able to research, produce, and sell your product and at the same time making a profit.

There are several instances of working capital cycles. A short working cycle for instance depicts an efficient cash flow. This means that the capital invested does not take a long time to mature and make the due interest. A good illustration to this is when a given company invests by contracting laborers and pays them within seven days. If the contractors finish the job and the product is sold within thirty days, then capital is said to have a working cycle of twenty-three days. There are companies on the other hand that receive payment before delivering on their services or goods. Such companies are said to have negative working cycles and thus the company has access to most of its capital thereby funding its growth is quite easy.

The diagrammatical representation of the working capital cycle makes it easy for the investors to have a clear view of the various cash inflows, how the cash is used for and the various cash outflows. A diagrammatical example of a working capital cycle is shown below. The arrows show the capital is circulated and converted. A liquidity crisis is created whenever the cycle breaks down and cash no longer flows in the system.

Having a clearly illustrated working capital makes it easy for the managers to calculate the total working capital cycle. The diagram is also necessary in identifying the various instances where the capital is being delayed. This will lead to one making the necessary changes or eliminating the process that is delaying the capital altogether depending on ones judgment.

The working capital of a business is crucial as it determines the strengths and the purchasing ability of the business entity. The working capital in essence is obtained by subtracting the current assets from the current liabilities of the business. This amount is the total of what can be easily liquefied by the business into cash to continue with the necessary business transaction. When the assets outweigh the liabilities, then the resultant is known as a positive working capital. This shows that the business is in a healthy financial position. The business can on the other hand have its liabilities outweighing the assets, and then the resultant is known as a negative working capital and is harmful to the business.

The various elements of working capital enable mangers investors to drive their business entities into profitability. One of the main elements of working capital is the cash at hand. This liquid cash is easily accessible by the business. This cash is either in the till or in the bank account. Liquid cash is paramount is paramount as it the central mode of acquisition of the necessary of the various materials or requirements for production. Cash is monitored by checking all the necessary cash inflows and balancing them with the cash outflows. The cash in a business enables the managers in the budgeting and forecasting processes.

Another element of the working capital is the accounts receivable. This is normally what stakeholders to the business entity owe the business. These are inevitable because in business, sometimes it is impossible to make cash payments thus resulting into debts. The managers ought to monitor and check on the accounts received properly because they end up withholding the amount of cash that is accessible in the business. When they accrue, cash flow in the business breaks and thus the business cannot continue smoothly.

The accounts payable are another element of the working capital. This is what the business entity owes other stakeholders. Sometimes it is necessary for the business entity to acquire materials or services yet it does not have access to the necessary payments thereby acquiring a debt. It is necessary for managers to mange this element because it may end up giving a false information on the cash that the business has. It may also restrict the business entity from the acquiring additional materials from the sellers. This would halt the company’s production line thus injuring the profitability of the company.

When the accounts payable are very overdue, it may lead the company to face litigation from the creditors in an effort to recover their cash. This would negatively affect the company in terms of goodwill. When the managers and the investors keep in check the above elements of the working capital, the business is bound to make profits thereby providing interest for the investment. The managers are also able to know the exact cause of any fault whenever the business entity reflects unrealistic profits or losses (Buck, 2002).

References

Buck, N. H. ( 2002). Working capital: life and labour in contemporary London. London: Routledge.