Many companies were in unpleasant situations associated with the sudden withdrawal of funds from circulation. The way out of them is extremely difficult and can be accompanied by large losses.
Relevance of the issue
Often, the director makes the decision to withdraw the amounts from the account to finance a project, assuming its payback and the possibility of paying off obligations to suppliers through this. Meanwhile, as practice shows, the scenario in such situations is standard. After some time, it turns out that there is not enough money for the delivered material and raw materials. Accordingly, it is urgent to seek additional sources, ask debtors to pay off their debt ahead of schedule, negotiate with banks, and so on. Similar cases occurred in large corporations that thoughtlessly changed the terms of settlement with suppliers and the provision of deferred payments to customers. For this, new contracts were concluded with contractors. Their essence was the refusal to use deferrals in exchange for a decrease in the purchase price of the goods. Along with this, customers purchased products at increased selling cost. However, they were provided with twice as much delay as before. A few months later, companies began to face an acute shortage of working capital. Accordingly, they had to urgently lend to banks. The company will not have problems with a shortage of current assets if management begins to tightly control the proportions between its own and borrowed capital, through which financing of operating activities is carried out . For this, it is necessary to develop an effective management model. It involves planning the duration of the operational and financial cycles. In addition, it will be necessary to determine current liquidity.
Enterprise operating cycle
It includes several processes. During it, in particular, the procurement of materials and raw materials, the creation of products, their sale, as well as debt repayment (if any) are carried out. Simply put, in the course of the operating cycle, a full turnover of assets takes place.
Key elements
The following components are distinguished within the operating cycle:
- Full turnover MPZ. It is also called the production cycle. It shows the average number of days that are needed to convert raw materials into finished products. Accordingly, it starts from the moment stocks arrive at the warehouse and ends when the finished goods are shipped to the consumer.
- Accounts receivable turnover. It represents the average amount of time needed to pay off customers who have purchased products on credit.
- Accounts payable turnover. It represents the period of time during which a company settles its obligations to other organizations.
Operational and financial cycle
If their reduction is noted in the dynamics, then this is considered a positive trend. The financial cycle represents the gap between the date of payment of obligations to counterparties and the receipt of funds from debtors (buyers). During this period, own funds make a full turn. The shortening of the operating cycle may be due to the acceleration of other operations. For example, the duration of storage at the plant, production of goods, and its maintenance in a warehouse are reduced. The duration of the operating cycle may also change under the influence of accelerating the turnover of receivables.
Turnover MPZ
Management effectiveness depends on the ratio of the duration of the financial and production cycle. The latter includes turnover periods:
- Commodity stocks.
- Work in progress.
- Stocks of finished products.
Production and operational cycle
To determine them, the corresponding equations are used. To calculate the duration of the production cycle, the following equation is used:
- HRC = POgp + POnzp + PoPz, where:
- POPZ - the number of days spent on the turnover of stocks of semi-finished products, materials, raw materials;
- PONZP - the number of days of turnover of work in progress;
- POGP - the duration of the turnover of stocks of finished products (products) in days.
The calculation of the operating cycle is carried out using the parameter found above. In addition, in the calculation, a value is used that characterizes the average debt turnover period of debtors. Their sum will show how long the operating cycle continues. The formula is as follows:
- OTs = PODZ + HR.
Relationship indicators
When analyzing the structure of working capital available to the company, the importance of time characteristics for ensuring effective capital management becomes clear. Of particular importance is the distribution of the needs of the company in current assets in specific periods. For calculations, a technique is used based on the duration of the financial and operational cycle and the estimated costs of current activities. The first indicator includes the time for the supply, manufacture and assembly of products, their sale, waiting for the repayment of buyers' debts. The financial cycle - the duration of cash circulation - is the period during which the funds do not participate in the turnover. Its duration can be determined as follows. From the indicator characterizing the operating cycle, the time of circulation of debt to creditors is deducted. Working capital management is carried out to reduce the period in which the funds are not involved. With a decrease in the duration of the financial cycle, respectively, the time for using its working capital becomes less.
Features of receivables
Obligations of counterparties act as an integral element of the work of any company. A large share of receivables in the overall system of assets significantly reduces the liquidity and solvency of the company, while increasing the risk of losses. The operating cycle of a modern company involves the dynamism of transactions. In today's conditions, much attention needs to be paid to debt of debtors. Often it is defined as a component of working capital. This element represents the specific requirements for organizations and citizens regarding payment for services, products or work. There is also a trend in which accounts receivable are identified with commercial credit. As a rule, the economic benefit of such obligations is expressed in the fact that the company, making the operating cycle, expects to receive money or equivalents. Accounts receivable in this case may be recognized as an asset if it is probable that it will be paid off. If it is absent, the amount of obligations is subject to write-off.
Sustainability management
To create an effective model, information from the budget of expenditures and revenues, some predicted indicators of balance sheet items are needed. A monthly breakdown is a mandatory requirement. The more often the budget execution process and, consequently, the solvency of the company are controlled, the better. When developing a model, turnover values and indicators of the duration of the operational and financial cycles will also be required. Of particular importance will be such quantities as:
- The need for short-term loans attracted to replenish working capital.
- Planned liquidity ratio at the current moment.
The first indicator is defined as the difference between the total need for working capital and equity. The calculation of the planned value of CTL can be carried out as follows:
- Ktl = POC x average expense per day / short-term liabilities.
This model allows us to understand how OZs and FCs affect the coefficient index.
Conclusion
Each manager must clearly understand what constitutes the operating cycle and the period of circulation of funds. Thanks to this, he can get all the necessary information to determine the need for his own assets. In addition, you need to understand the essence of the business, understand how the processes are built within the company, how optimal they are, whether there are reserves for optimization. In the course of the calculations, it is also necessary to take into account that the size of its current assets is continuously changing throughout the year. In this regard, each month, when comparing actual and planned indicators, monitoring of the adjustment of the model parameters should be constantly monitored. To ensure that not only the financial director has an understanding of the significance and importance of cycle times, it is advisable to determine the responsibility of the heads of departments for each element. This can be done by linking the existing system of bonuses and bonuses with the required indicators.