The operating cycle of a manufacturing unit means the length of time required to convert ‘Non-Cash current assets’, (like raw material (RM), work in process (WIP), finished goods (FG), and receivables) into cash. The appraisal of working capital finance means the assessment of gross working capital, net- working capital and working capital gap for assessment of working capital limits for a company.
In normal circumstances, every unit of Cash investment in working capital is converted to cash at the end of the cycle. Therefore, operating cycle is also known as cash to cash cycle or production cycle.
Various stages of operating cycle can be explained by the following diagram.
The starting point of operating cycle is cash paid towards the purchase of raw material; labour and other overheads in the production process and produce work in process. The work in process converted into finished goods. Finished goods are converted into Receivables. The receivables turned into cash. The cash again will be converted into inventories, receivables, and cash.
The appraisal of working capital finance will be arrived from working capital gap based on the number of days taken for completing a operating (cash) cycle.
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