Question 3 OR (i)
Operating cycle
5 marks
- Time to write
- About 10 minutes
From an older CBCS paper
Question
Question 3 OR (i) · 5 marksWrite short notes on these:
- Operating cycle
Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- short notesA note opens with the meaning, then two or three key points. No long introduction.
What the paper leaves open
One of the three notes in the printed Q3 OR; the second note (ABC system of inventory management) is outside the current syllabus.
Write it in this order
- Read; underline the asks; jot your points 1 min
- 1 Meaning 1 mark 1 min
- 2 Components and their measurement 2 marks 3 min
- 3 Gross and net cycle; number of cycles 1 mark 2 min
- 4 Use in estimating working capital 1 mark 2 min
- Check: every ask answered, key terms underlined 1 min
Easy marks
- Meaning (step 1, 1 mark): a definition in one or two lines. It opens the answer, so it takes a minute or two.
Try it first. About 10 minutes for 5 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Meaning. Working capital is needed because there is a time gap between production and the realisation of cash from sales: the firm passes through an operating cycle of buying raw materials, producing, selling and collecting cash. The operating cycle is the time taken to convert cash into raw materials, raw materials into work in progress and finished goods, finished goods into debtors, and debtors back into cash.
1The carpenter's cash becomes a cartload of timber.
Raw material storage periodCash is turned into raw materials.
2Saw and hammer turn the timber into half-made chairs.
Conversion (work-in-progress) periodRaw materials into work-in-progress.
3The finished chairs line the store room, ready.
Finished goods storage periodWork-in-progress into finished goods.
4The chairs go out on credit, and Lakshmi's notebook follows the money home.
Debtors' collection periodFinished goods into debtors and debtors back into cash.
Components (each measured as the average balance divided by the matching flow per day):
- Raw material storage period (R) = average raw material stock ÷ raw material consumed per day;
- Work-in-progress period (W) = average WIP ÷ cost of production per day;
- Finished goods storage period (F) = average finished goods ÷ cost of goods sold per day;
- Debtors' collection period (D) = average debtors ÷ credit sales per day;
- Creditors' payment period (C) = average creditors ÷ credit purchases per day.
Gross and net cycle. Gross operating cycle = R + W + F + D; net operating cycle = R + W + F + D − C, since supplier credit finances part of the cycle. Number of operating cycles in a year = 360 (or 365) ÷ operating cycle; the more cycles, the shorter each cycle and the better for the firm.
Use. The length of the net operating cycle decides how much working capital is needed: the longer the cycle, the more funds are blocked in current assets. Shortening it, by faster production, quicker collection or longer supplier credit, reduces the working capital requirement.
Where the 5 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Meaning | 1 |
| 2 | Components and their measurement | 2 |
| 3 | Gross and net cycle; number of cycles | 1 |
| 4 | Use in estimating working capital | 1 |
| Total | 5 |
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