Four General Four Phases of the Working Capital Cycle
Working capital, defined as the money required to facilitate day-to-day business activities, undergoes through a cycle known as the working capital cycle. Once the supplier supplies goods or inventory, the businessperson pays for the supplies and then waits to get back the money after sale. Working capital cycle them measures the time between when the businessperson pays for supplies to the time of receiving money after sale (Government of Western Australia, 2013). The cycle has four parts as follows:
- Cash: Getting the required cash
- Creditors: Converting some or all the cash into resources, which could include inventories, paying wages and salaries, paying bills or paying creditors
- Inventory: selling inventory or using it to provide services
- Debtors: collecting revenues and billing for services, which enables the business to get back its cash for the cycle to continue (Government of Western Australia, 2013)
The four phases follow each other as shown below
The Three Primary Sources of Short-Term Funds
A business may get short-term funds from any or a combination of the following three sources: bank loans, credit extension and accounts receivables. A business can get a loan from a bank if it requires cash for various purposes such as business expansion and purchase of new equipment or inventory (Zelman et al., 2009, p. 160). The second source of short-term funds is credit extension especially if a business has good terms with its suppliers. The advantage with this source of short-term funds is that it is not as expensive as bank loans because suppliers only have to provide supplies to be paid later (Zelman et al., 2009, p. 160). The business then strives to sell goods and services soonest possible to get cash before time agreed to pay for supplies elapses. The third source is accounts receivable, which involves increasing money collection speed such as using disbursement, collection and billing policies. This enables the business to collect money quickly to get funds to finance other operations such as pay for inventories (Zelman et al., 2009, p. 160).
Four Areas for an Organization's Short-Term Investment Options for Idle Cash
Sometimes an organization can have idle cash that it wishes to invest. The organization can invest this cash into any or a combination of the following investment options. The first one is treasury bills, which are sold by the government to raise required money. They are short-term obligations, and the organization can get back its money within a short time (Ferrell, Hirt and Ferrell, 2011). The second option is consumer certificates of deposits (CDs) that commercial banks issue to raise money and the organization must wait until CDs mature to get back its cash. Commercial CDs provide another investment option and the good thing with these is that the organization can trade them even before they mature to get back its money. Finally, an organization can buy shares of another company, which it can wait to get dividends at the end of financial year or sell through stockbrokers especially if share prices increase (Ferrell, Hirt and Ferrell, 2011).
Float is the time taken after billing is done and when payment for goods and services is collected, which affects an organization’s liquidity (Cleverley, Song and Cleverley, 2011, p. 523). Time between provision of service or delivery of good and bill generation is known as billing float. Time between bill generation and cash collection is known as collection float. Time between payment for products and services and the availability of funds (time taken for a check to mature) is known as transit float (Cleverley, Song and Cleverley, 2011, p. 523).
Cleverley, W., Song, P. & Cleverley, J. (2011). Essentials of Health Care Finance (7th ed.). Sudbury, MA: Jones & Bartlett Learning
Ferrell, O., Hirt, G. A. & Ferrell, L. (2011). Business: A Changing World. Retrieved from http://highered.mcgraw-hill.com/sites/007246917x/student_view0/chapter16/cybersummary.html
Government of Western Australia (2013). Working Capital. Retrieved from http://www.smallbusiness.wa.gov.au/working-capital/
Zelman, W. N., McCue, M. J., Millikan, A. R. & Glick, N. D. (2009). Financial Management of Health Care Organizations: An Introduction to Fundamental Tools, Concepts, and Applications. John Wiley & Sons.