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3. The components of the operating cycle Aa Aa Proper management of a firm's working capital is vital and challenging due to the and between a firm's cash inflows and outflows. The flows of cash and goods into and out of a firm can be depicted visually using several models, including a timeline and a cycle or circular flow. The operating cycle focusses on both(1) the movement of its raw materials and its finished and saleable products, and (2) the associated financial transactions and cash flows, and can be expressed using two equations Equation 1: Operating Cyde = Inventory Conversion Period + Receivables Collection Period Equation 2: Operating Cyde = Payables Deferral Period + Cash Conversion Cyde Knowledge of the timing of these activities and flows is critical because it helps you maintain the firm's liquidity and solvency. It gives you the information so that you can plan for potential cash shortages and work to raise the necessary additional capital the deficiency occurs According to Equation 1, the operating cycle focusses on the flow of raw materials and finished goods through the business and the sale of these goods to the company's customers, and the amount of time associated with these activities. Based on this perspective of the operating cycle, the operating cycle cab be broken down into the following two parts-depending upon how the business's firm's funds are invested the amount of time needed for the business to obtain its raw materials, transform them into finished goods and sell them on credit to the firm's customers, which is called the period; and the time period during which the finished product is sold to a credit customer and the corresponding account receivable is created and the customer's cash is ultimately collected, which is called the period The other perspective on the operating cycle, described in Equation 2, focusses on the financial transactions that accompany the two investments described in Equation 1: the accounts firm's raw materials, and the accounts on the time gap that is created when the accounts payable are repaid before accounts receivable are collected. This vie of the operating cycle also consists of two components that are used to purchase the that are created when the finished goods are sold. It also focusse the payables deferral period, begins with the creation of an account and concludes with its repayment. Also called the that the company is able to postpone its payment for its credit purchases of raw materials. the cash conversion cycle, describes the time that elapses between the materials and the collection of funds resulting from the credit sale of the finished product. this period corresponds to the time interval for the raw