Operation cycle method considers total cycle of operations, from raw materials to finished goods, from accounts payable to net cash.
The times taken to complete these operations are called operating cycle time.
If the operating cycle is long then, requirement of working capital is less, if the operating cycle is less then, requirement of working capital is less.
Here, CGS (E) = estimated cost of goods sold, D = days in operating cycle, CB = Cash/Bank balance
Here, PU(E) = production units estimated, Cu = cost per unit, HP = holding period of RM
Here, P(E) = production estimated, Cu = unit cost, RM (100%), L(50%) =Labour, OH (50% = overheads), WIP = work in progress
Here, P(E) = production estimated. CGSp = unit cost of goods produced, HPfg= holding period of finished goods
Here, P(E) = production estimated , SP = selling price, CP = Collection period
Here, P(E) = production estimated, RMu = RM cost per unit, PP = payment period
Operating cycle = IP + ARP
Here IP = Inventory period, ARP = Accounts receivable period
Advantages of this method include −
Disadvantages of this method include −
Cost of goods sold = Rs.5000000/- Operating cycle = 100 days Cash/bank balance = 600000/- Now, calculate the working capital.
The solution is mentioned below −
Working capital = CGS(E)* D/365 + CB Here CGS (E) = estimated cost of goods sold, D = days in operating cycle, CB = Cash/Bank balance Working capital = 5000000 * 100/365 + 600000 Working capital = Rs1969893/-
Working capital is further divided into each component (inventory, cash etc.)