Financial cycle - an indicator of the efficiency of the enterprise

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

The financial cycle is the period that is concluded between the date of repayment of accounts payable (payment by buyers of materials and raw materials received from suppliers) and the date of repayment of receivables (receipt of funds from buyers for the products they received). The second name of this concept is the cycle of money circulation.

The financial cycle has a duration defined by the following formula:

PFC=POPP + SUPPLY - POPP, where POPP is the inventory turnover period;

PODZ - an indicator of the period of circulation of receivables;

POKZ - an indicator of the period of circulation of accounts payable.

Based on the foregoing, the duration of the cash cycle is characterized by the average duration associated with the outflow of funds in the implementation of the main production activity, and the inflow as a result of their production and financial activities.

In other words, the financial cycle is the time for whichfunds are withdrawn from circulation. This indicator is necessary when determining the effectiveness of the entity's economic activity.

A company always has a reserve at its disposal, which it can use if necessary. We are talking about cash resources represented by accounts payable. Indeed, the money invested in production cannot be simply withdrawn from there in order to cover their short-term shortage. Therefore, there is no question of sales of inventories at reduced prices. The same is true for accounts receivable. To obtain additional funds, a business entity seeks certain changes in relations with debtors.

The financial cycle of the enterprise shows the effective regulation of the same accounts payable. Thus, the moment of payment can be successfully managed, and in the event of a critical situation, the repayment of such debt can be delayed. In other words, it is accounts payable that indirectly regulates the volume of current cash and should be taken into account when assessing the company's financial performance.

When analyzing the subject's activities, specialists note the relationship between the operating and financial cycles, but at the same time they describe various aspects of the enterprise's functioning. So, with the help of the operating cycle, a characteristic of the production and technological aspects of the company's activities is given. It shows the timewhich financial resources are frozen in the form of inventories and receivables.

The financial cycle shows precisely the financial aspect of the activity. Due to the payment of bills, the company has a certain time lag - the time for which financial resources are withdrawn from circulation is less than the average turnover of accounts payable.

With the dynamic shortening of the operating and financial cycles, experts regard this fact as a positive trend. The reduction in the size of the operating cycle is carried out mainly by increasing the speed of the production process and accelerating the turnover of receivables. And the financial cycle can be reduced due to some reduction in the turnover of accounts payable.