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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
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 Cycle = Inventory Conversion Period + Receivables Collection Period Equation 2: Operating Cycle = Payables Deferral Period + Cash Conversion Cycle 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 _____ that are used to purchase the firm's raw materials, and the accounts _____ that are created when the finished goods are sold. It also focuses on the time gap that is created when the accounts payable are repaid before accounts receivable are collected. This view of the operating cycle also consists of two components: the payables deferral period, begins with the creation of an account _____ and concludes with its repayment. Also called the _____, this period corresponds to the time interval 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 _____ for the raw materials and the collection of funds resulting from the credit sale of the finished product. In general, a manufacturing firm is required to pay its accounts payable, a spontaneous _____ of funds, before it receives the cash inflow from the collection of its account receivable, a spontaneous _____ of funds. This means that the firm may require an additional, non-spontaneous _____ of financing to cover this period to ensure the firm's liquidity and solvency. The equation that best represents the firm's cash conversion cycle as function of the firm's payables deferral period (P), receivables conversion period (R), and inventory conversion period (I) is: I = R + P P + I - R (I + R) - P
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