The operating cycle encompasses two major short term

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Unformatted text preview: eginning of the production process to collection of cash from the sale of the finished product. The operating cycle encompasses two major short-term asset categories: inventory and accounts receivable. It is measured in elapsed time by summing the average age of inventory (AAI) and the average collection period (ACP). OC AAI ACP (14.1) However, the process of producing and selling a product also includes the purchase of production inputs (raw materials) on account, which results in accounts payable. Accounts payable reduce the number of days a firm’s resources are tied up in the operating cycle. The time it takes to pay the accounts payable, measured in days, is the average payment period (APP). The operating cycle less the average payment period is referred to as the cash conversion cycle (CCC). It represents the amount of time the firm’s resources are tied up. The formula for the cash conversion cycle is CCC OC APP (14.2) Substituting the relationship in Equation 14.1 into Equation 14.2,...
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