Introduction to Operating Cash Cycle
While assessing the liquidity of a business, it is significant to be aware of the operating cash cycle (OCC). In the matter of a business which purchases goods on credit for consequent resale on credit (for instance, a wholesaler), this might be described as the time period among the outlay of cash essential for the purchase of inventories and the final receipt of cash from the credit customer.
Figure: depicts that payment for inventories obtained on credit takes place sometime after those inventories have been purchased and, so no immediate cash outflow occurs from the purchase. Likewise, cash receipts from credit customers will take place sometime after the sale is made. So, there will be no immediate cash inflow like a result of the sale. The operating cash cycle (OCC) is the time period among the payment made to the supplier for goods and the cash that received from the credit customer. However Figure 7.2 depicts the position for a wholesaling business, the definition of the operating cash cycle (OCC) can simply be adapted for other types of businesses, like manufacturers and retailers.
The operating cash cycle (OCC) is significant because it has an important affect on the financing needs of the business. Generally speaking, the longer the cycle, the greater the financing needs of the business and the greater the financial risks. Because of this reason, a business may want to decrease the OCC to the minimum possible period.
For the kind of business which buys inventories and then sells them on credit, the operating cash cycle (OCC) can be computed from the financial statements through using specific ratios.
The calculation is as displayed in Figure as follow:
Figure: calculating the operating cash cycle
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