The operating cycle examines the resource typically

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The operating cycle examines the resource typically tied up within a given company’s trading cycle. Imagine that on day one, the company buys items on credit from a supplier and takes 78 days to pay the invoice. The items sit on the shelf for 161 days and then are sold to a customer who then takes 131 days to pay the invoice. For the first 78 days there is no effect on the company's cash flow, as the first 78 days of the stock holding period are in effect being financed by the supplier. After day 78 there are still 83 (161 - 78) more days that the stock spends on the shelf, during which time no cash flows into the business. Even once the items are sold, the business still has a further 131 days to wait before any cash flows into the business, thus the company is starved of cash for 83 + 131 days i.e. 214 days. The business must find ways to finance itself, perhaps through borrowing, during those 214 days as measured by the operating cycle. 62 12/01/19
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commentary The increase in Exemplen’s inventory turnover period (12 days longer this year) & receivables collection period (15 days longer this year) are both detrimental to the company’s cash flow, although the 10 day extension in the trade payables payment period does compensate slightly for this. Overall at 214 days the cycle is 17 (12 + 15 – 10) days longer this year than last, which brings additional costs to the company & pressure on its cash flow. The days figures are averages & for an established business each £ worth of value will be at a different stage in its journey through the cycle. It can be hard for businesses starting up to finance themselves through those early days, but once established there is a constant churn of working capital through the pipeline. 63 12/01/19
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  • Fall '15
  • Generally Accepted Accounting Principles, Exemplen Ltd

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