FREE online courses on How to Manage Cash Flow - Chapter 1 - Measuring Cycle
Times
In order to monitor
progress in managing cash, it is useful to understand how much cash is
locked-up; i.e. not available to us. We can get an idea of cycle times by
looking at average days in inventory, average days in receivables, and average
days in payables. These three components cover the two basic cash flow cycles,
disbursements and receipts.
a: Average Days in Inventory = Average Inventory Balance / Average Daily Cost of
Goods Sold
b: Average Days in Receivables = Average Receivable Balance / Average Daily
Credit Sales
c: Average Days in Payables = Average Payables Balance / Average Daily Purchases
on Account
The overall cash flow
cycle time is calculated as: a + b - c; i.e. inventory and receivables tie up
cash receipts less payables for disbursements. This calculation is illustrated
in Example 5.
Example 5 - Calculate
Cash Flow Cycle Time
Average Monthly Activity
for selected financial accounts is as follows:
Credit Sales
$ 950,000 Accounts Receivable
$ 1,300,000
Purchases
$ 525,000 Inventory
$ 550,000
Cost of Goods Sold $ 700,000
Accounts Payable $ 200,000
Average Days in Accounts
Receivable = 1,300,000 / (950,000 / 30) = 41
Average Days in
Inventory = 550,000 / (700,000 / 30) = 24
Average Days in Accounts
Payable = 200,000 / (525,000 / 30) = 11
Total Cash Flow Cycle
Time = 41 + 24 - 11 or 54 days.
You also can plot cash
flow cycle times by looking at the activity times within each cycle.
Example 6:
|
Inventory
|
Accounts
Receivable
|
Accounts
Payable
|
|
Activity
|
Days
|
Activity
|
Days
|
Activity
|
Days
|
|
Process Requisition
|
1
|
Capture Sales Order
|
2
|
Receive Invoice
|
4
|
|
Process P. Order
|
3
|
Fill out customer
order
|
6
|
Approve Invoice
|
4
|
|
Production Time
|
12
|
Deliver Order
|
2
|
Process Invoice
|
3
|
|
Inspect / Move
|
1
|
Invoice Customer
|
2
|
Prepare & Mail Check
|
3
|
|
|
|
Receive Payment
|
36
|
Check Clears Bank
|
6
|
|
|
|
Payment Clears Bank
|
5
|
|
|
|
|
|
|
|
|
|
|
Total Days
|
17
|
|
53
|
|
20
|
Total Cash Flow Cycle
Time = 17 + 53 - 20 = 50 days
Once we have determined
cash flow cycle times, we can move to the next step in cash flow management,
planning.
