Sometimes referred to as a cash conversion cycle, the cash cycle has to do with the amount of time that passes between the purchase of raw materials for the creation of goods and services and the receipt of payment for those products. The concept can also be applied to the transaction process related to securing stocks and similar securities. A key factor in the idea behind calculating this cycle is to understand the period of time when working capital is not available for use in other purchases.
When it comes to the manufacturing process, the cash cycle begins with the acquisition of the materials needed to produce finished goods. The cycle continues through the time required to use the materials to create the products, package them, and deliver them to customers. Once the client is invoiced for the delivered goods, the last step begins. The cycle is considered complete when the Accounts Receivable department receives and posts payment in full on the invoice covering the delivered goods.
The duration of a cash cycle will vary, depending on several factors. First, the amount of time that is required to create the product is an important aspect of the calculation as goods that can be produced quickly help to shorten the cycle considerably. Next, the amount of time spent inspecting, packaging and shipping the finished product will add to the overall length of the cash cycle. The amount of time that it takes for the client to remit payment for the finished goods will add to the length of the cycle as well.
A short cash cycle is the ideal situation, as it allows the company to take advantage of the working capital sooner rather than later. There are often ways to shorten a longer cycle and achieve a more efficient process. For example, refining the manufacturing and shipping procedures may shave off hours or even days. In addition, offering incentives to the customer to pay for the goods quickly will also help shorten the overall cycle significantly.