Tip:
Highlight text to annotate it
X
The traditional academic formula for determining Cash Conversion Cycle is
Days Sales Outstanding
plus Days Inventory in Stock
less Days Payables Outstanding.
We have defined the working capital in previous episodes.
We also revealed the relationship between the Cash Conversion Cycle and the Working
Capital.
At �Working Capital definition � the management approach� episode we defined working capital
as the total amount of money invested in the operating cycle of the company.
Grounding on that we can claim that the Working Capital can be defined using the same elements
that we have used for Cash Conversion Cycle.
The only difference is that we take them in dollar value, not time measured.
So, company invests money in Accounts Receivable since clients use company�s money taking
an advantage of the delay in payment.
It also has some money frozen in inventory.
Finally, company uses its vendors� money, experiencing an advantage of the delay in
payment granted by suppliers.
With that, we come with the three-element structure of the working capital.
Working capital is the part of investments company has to have in order to run business.
That is the amount of money that frozen in business.
Going across the operating cycle, you still can notice one more ice cube.
In real life, companies always have some cash remained on their checking or savings accounts.
There is an average cash remains around the whole year.
That is the part of money that does not actually work!
Why that happened?
Probably because financial executives tend to have some money in the pocket to hedge
against the uncertainty.
Anyway, that portion of money should be considered as a part of the working capital iceberg.
That is definitely, the part of money company needs to invest in order to keep business
running.
Especially, cash remains should not be forgotten when think about optimization of the working
capital.
Every dollar invested in the working capital should work efficiently.