Similar to the turnover period of the current assets of the enterprise as a whole, we can consider the turnover period of each element of the current assets. The turnover period of a specific current asset gives a time characteristic of the corresponding stage of the cost cycle. For example, the turnover period of an asset “work in progress” characterizes the number of days that money is delayed at stage 3 of the production and commercial cycle, i.e. the duration of the product production process at the enterprise.
The total value of the turnover periods of the five stages of the production and commercial cycle forms its value.
The larger the cost cycle, the greater the enterprise’s need to finance the production process.
Financing of production activities can be carried out from internal sources arising in the process of conducting production activities. These include accounts payable, i.e. trade credit from suppliers, advances from buyers, funds from accrued but unpaid wages and taxes (sustainable liabilities). These internal sources form the credit cycle.
Credit cycle (LC):
The size of the credit cycle is formed as the sum of the turnover periods of each of its three elements. The accounts payable turnover period has the economic meaning of the average number of days for which suppliers credit our company while waiting for the return of funds for their goods. The turnover period for customer advances is the average number of days for which customers advance the receipt of goods or services from our company or the average period for payment of invoices issued by our customers. The turnover period of stable liabilities is the average frequency of payment of taxes and wages.
"Clean cycle" is the difference between the cost and credit cycles of an enterprise.
As a rule, the cost cycle exceeds the credit cycle and there is a positive value of the net cycle. During the “clean cycle” period, the enterprise is deprived of the opportunity to attract internal funds from participants in the business process (suppliers, creditors, the state and its own employees and must use external sources, such as bank loans or equity capital - accumulated profits of previous years.
There are cases when the credit cycle is greater than the cost cycle and the net cycle takes negative values. Most often, this situation occurs in trading enterprises that receive goods from the manufacturer on the basis of payment after its sale or in service sector enterprises that take significant amounts of advances from their clients, for example, commercial educational institutions in which prepayment of tuition is made for a year or semester.
To conduct a financial analysis of turnover, it is necessary to calculate the turnover periods of all cost and credit cycles. Calculations of the turnover periods of all current assets and liabilities are carried out using the following formula:
Turnaround period =.
For each asset and liability, a different calculation basis is used, which can be determined according to the following table.
Table 9
Calculation base table
|
Asset (liability) |
Calculation base |
|
Accounts receivable |
Revenues from sales |
|
Advances from buyers |
|
|
Accounts payable |
Cost of sales of products + Selling expenses + Administrative expenses |
|
Advances to suppliers |
|
|
Sustainable Liabilities |
|
|
Productive reserves |
Material costs (the part of the cost that falls on material costs) |
|
Unfinished production |
Cost of sales of products |
|
Finished products |
When calculating turnover periods in relation to sales revenue, three main indicators are of particular importance: the turnover period of current assets (excluding cash), the turnover period of current liabilities (excluding loans) and the difference between the indicated values.
The turnover period of current assets, with the exception of cash (the sum of the turnover periods of individual elements of current assets, with the exception of cash), is called the cost cycle. The longer the cost cycle, the longer the period of time the money is “tied up” in current assets (the more distant the moment of receiving “new money”).
The growth of the cost cycle indicates a change in the working capital management conditions towards unfavorable ones for the enterprise, i.e. on reducing the efficiency of using current assets. An increase in the cost cycle contributes to a decrease in return on capital, and a reduction in the cost cycle contributes to an increase in profitability. An increase in the cost cycle can also contribute to a decrease in liquidity and financial stability indicators (as it contributes to the growth of current liabilities as sources of financing for the growth of assets).
It is no coincidence that the cost cycle received such a name. Formation of reserves and implementation of expenses requires appropriate sources of financing. The larger the cost cycle, the greater the enterprise’s need to finance the production process. Financing of production activities can be carried out from sources that appear during production activities and from sources external to the production process. In this case, external sources of financing mean an increase in the company’s equity capital, attraction of borrowed funds and loans.
Example from practice. Analysis of the efficiency of management of the company's current assets
In the example given in table. 3.3, there is a steady upward trend in the cost cycle: the conditions for managing current assets are becoming increasingly unfavorable for the enterprise (Company 4, see Chapter 7), and the efficiency of working capital management is decreasing. The deterioration of working capital conditions is observed in terms of accounts receivable and finished products. In other words, in the period under review, the payment discipline of buyers significantly deteriorated (at the enterprise, the efficiency of collecting the buyer's debt decreased), and the percentage of finished products sitting in the warehouse increased several times.
The growth of the cost cycle contributed to a decrease in return on capital (in all periods the company’s activities were profitable, so the reason for the decrease in profitability was precisely the decrease in asset turnover). An increase in the cost cycle means the emergence of a need to finance the production process. However, the final conclusion about whether working capital required additional financial resources (in the form of loans or equity) can only be made after analyzing short-term liabilities.
Table 3.3. Calculation of turnover periods for elements of current assets Position name Reporting dates
01.01.2003 01.01.2004 01.01.2005 01.01.2006
732 20 842
Balance
Cash Total current assets
775 17 351 7201
42 737 131 084 2/6 885 End of table. 3.3 Position name Reporting dates 01/01/2003 01/01/2004 01/01/2005 01/01/2006 Current assets excluding cash 20,110 41,952 122,957 269,684 with funds Profit and loss statement Profit from sales 0 125,737 27 8 425 423 301 Revenue for period 0 125 737 278 426 423 301 Cost cycle, days 88.9 106.6 167.0 For the last period 0.5 x (269 584 + 122 957)/(423 301/360 days) = 167 Including turnover periods : inventories of materials 26.1 23.3 25.1 work in progress 4.3 3.2 3.2 finished goods 16.9 19.1 24.2 accounts receivable: debts 2.8 39.1 105.0 other current assets 38 .7 22.0 9.5 Profitability indicators Return on total capital 12.4% 27.8% 26.4%
Short-term liabilities (current liabilities) are sources of financing arising from the conduct of production activities. In particular, these sources are current debt to suppliers (accounts payable), current debt to the budget and personnel, as well as advance payments from customers. Debt to the budget (arising due to the established frequency of tax payments) and wage arrears (arising due to the frequency of payment accepted in the organization) are often called stable liabilities.
The turnover period of all short-term liabilities, with the exception of short-term loans (the sum of the turnover periods of individual elements of current liabilities, with the exception of short-term loans), is called the credit cycle. The longer the credit cycle, the more effectively the enterprise uses the opportunity to finance current activities at the expense of direct participants in the production process.
The growth of the credit cycle indicates a change in the conditions for managing working capital in the direction favorable for the enterprise: the sources of financing obtained during the current production process are becoming more numerous. The above statement is true if the turnover periods
individual components of current liabilities have acceptable values, i.e. the organization does not create excess debts to suppliers, budget, or personnel.
Example from practice. Analysis of the effectiveness of the company's use of short-term liabilities
Item name
Table 3.4. Calculation of the period of turnover of elements of current liabilities 01/01/2С 03 01/01/2004 01/01/2005 01/01/2006 Balance Short-term loans 0 0 0 0 Total short-term liabilities 11,258 16,765 57,532 235,294 Short-term liabilities for 11 2 58 16,765 57,532 235,294 excluding short-term loans Revenue for the period 0 125 737 278 426 423 301 Credit cycle, days 35.7 47.2 124.5 For the last period 0.5 x (57,532 + 235,294)/(423,301/360 days) - 124.5 Including turnover periods: accounts payable 19.2 23.2 70.7 settlements with the budget and personnel 7.8 4.6 5.0 other short-term liabilities 8.7 19.4 48.8 Profitability indicators Return on total capital 12.4% 27.8% 26.4% Bolane Debt to participants for payment 4,922 income 531 50,765 Deferred income 0 0 0 Reserves for future expenses 1,860,746 1,217 Other short-term liabilities 0 0 0 In the example given in table. 3.4 for Company 4 (see Chapter 7), there is a tendency for the credit cycle to increase. Its increase occurred primarily in the period of turnover of accounts payable, advances from customers and other liabilities. The increase in the period of turnover of accounts payable indicates that the company gradually increased the deferment in payment of invoices presented by suppliers (in the last period it sharply increased). The growth of advance payments from buyers indicates a gradual increase in the period of prepayment on the part of buyers, i.e. about more favorable conditions for the enterprise for the shipment of finished goods! products.
An analysis of the initial balance sheet showed that the increase in other current liabilities is a consequence of the outstanding debt to the founders for the payment of income. In the last reporting period, unpaid income to the founders became a source of financing for current production activities. However, in the future, most likely, this debt will be repaid: the company will have to “part with” this source of financing and think about replacing it with another source.
Comparing the dynamics of change in both cycles, it can be noted that the growth of the credit cycle in many cases was a forced response measure: with an increase in the need for financing current assets, the company in a similar way tries to “compensate” for cash gaps.
In the example from table. 3.4 the need for additional financing, which arose due to the increase in the payment period for invoices from buyers, was “compensated” by a similar deferment of payments to suppliers.
How to view the growth of accounts payable as a positive or negative factor? From the point of view of eliminating cash gaps, the increase in debt to creditors can be called a positive development, since this made it possible to finance the growth of current assets without attracting credit resources, which “cost money” in the form of interest." If the increase in deferment in payment of supplier bills caused the accrual of fines, penalties or loss of suppliers, then the immediate positive effect will be replaced by negative consequences after a certain period of time. Looking ahead a little, we note that in this situation the conclusion about a decrease in overall liquidity due to an increase in accounts payable and recommendations for its reduction will be incorrect. Regardless of the increase. Whether it is accounts payable or short-term loans, the increase in current liabilities will be the same (both elements represent current liabilities), therefore, the value of the total liquidity ratio will be the same. In this case, the reason for the reduction in the total liquidity indicator is not the increased short-term debt itself. , but an increase in current assets, which caused an increase in short-term liabilities.
The difference between the cost cycle and the credit cycle is called the clean cycle. This is an indicator characterizing the organization of financing the production process. The clean cycle is part of the cost cycle, financed not at the expense of direct participants in the production process, but at the expense of sources of equity capital growth external to the production process, loans. The larger the indicator, the less favorable the working capital management conditions for the enterprise. A negative value of the net cycle indicates that loans from suppliers and buyers more than cover the need for financing the production process and the enterprise can use the resulting “surplus” for other purposes, for example, to finance non-current assets.
The change in net nickel reflects the impact of working capital management conditions on the company's need for financing. The growth of the net cycle is a negative trend and means that the conditions for managing working capital have undergone changes that have contributed to the growth of the company's need to finance the production process. The reduction of the net cycle is a POSITIVE trend: in this case, the conditions for managing working capital have changed in such a way that they have reduced the company’s need to finance the production process and contributed to the “freeing up” of cash.
It must be remembered that the influence of working capital management conditions on the need for financing is indicated by a change in the net cycle, but not by the value of the net cycle itself. The constant value of the net cycle indicates that in the analyzed period the conditions for managing working capital did not in any way affect the enterprise’s need for financing
Example from practice. Conclusion on the influence of working capital management conditions on the company’s need for financing
Position name, days Reporting dates
01/01/2003 01/01/200J 01/01/2005 01/01/2006
Table 3.5. Calculation of the pure cycle and analysis of its dynamics Cost cycle 88.9 106.6 167.0 Credit cycle 35.7 47.2 124.5 Clean cycle 53.2 59.4 42 f 4 Thus, in the example presented in table. 3.3-3.5, changes in the working capital management conditions had an ambiguous effect on the company’s condition. From the point of view of return on capital, the impact was negative, from the point of view of maintaining absolute liquidity - positive.
It is important to note that in the subsequent period the company expects a deterioration in the conditions for managing working capital, in particular a reduction in one of the sources of financing for the last reporting period - debt to the founders. As a matter of fact, due to the occurrence of this debt, the company managed to improve the conditions for managing working capital.
In the example given in table. 3.5 for Company 4 (see Chapter 7), during the first two years, working capital management conditions do not affect the company's need for financing. This is evidenced by the constant value of the clean cycle. In the last reporting period, a change in the conditions for managing working capital contributed to the emergence of additional financial resources. This is evidenced by a reduction in the net cycle from 53 to 38.5 days.
scrap, “get” additional sources of financing. Having analyzed the absolute values, we will see that due to the increase in the turnover period of other current liabilities from 19 to 49 days (i.e., 30 days), a reduction in the net cycle was achieved from 59 to 42 days (17 days). If the debt to the founders had not arisen (the net cycle would have remained at the same level), the enterprise would most likely have been forced to attract short-term lending as additional sources of financing. Repayment of debt to the founders will lead to an increase in the net cycle, i.e. the need for financing arises. This point is clear even without any “cycles”: paying off debt will require financial resources. How critical (non-critical, acceptable) the repayment of debt to the founders will be for the enterprise can be determined by analyzing the liquidity and financial stability ratios (which will be done later).
When characterizing the turnover of current liabilities, one had to face the question of why short-term loans, which are a component of current liabilities, were not included in the credit cycle. The answer is obvious: the task of analyzing turnover and calculating the net cycle is to assess the need (determining the growth or reduction of need) for external sources of financing loans. Thus, in the turnover analysis, loans are the desired, but not the initial, parameter, and therefore do not participate in the calculation of the credit cycle.
Table 16a
Analysis of business activity indicators (in days) |
|||
Name | |||
Return on assets, days | |||
Return on fixed assets (capital productivity), days | |||
Inventory and cost turnover ratio, days | |||
Turnover ratio of current assets, days | |||
Accounts receivable turnover ratio, days | |||
Accounts payable turnover ratio, days | |||
Return on equity capital, days | |||
Clean cycle calculation |
|||
Inventory turnover, days | |||
Accounts receivable turnover, days | |||
Turnover of other current assets, days | |||
Cost cycle, days | |||
Accounts payable turnover, days | |||
Production cycle, days | |||
Clean cycle, days |
An analysis of business activity indicators (in turnover) for the analyzed period is presented in table No. 17.
Table 17
Business activity indicators (in turnover for the period) - Changes |
||||
Name | In abs. expression | Rate of increase |
||
Return on assets, about | ||||
Return on fixed assets (capital productivity), about | ||||
Turnover of current assets, volume | ||||
Inventory turnover and cost ratio, vol. | ||||
Current assets turnover ratio, vol. | ||||
Accounts receivable turnover ratio, volume | ||||
Accounts payable turnover ratio, volume | ||||
Return on equity capital, about |
An analysis of business activity indicators (in turnover) for the entire period under review is presented in table No. 17a.
Table 17a
Business activity indicators (in turnover for the period) |
|||
Name | |||
Return on assets, vol. | |||
Return on fixed assets (capital productivity), vol. | |||
Turnover of current assets, vol. | |||
Inventory turnover and cost ratio, vol. | |||
Current assets turnover ratio, vol. | |||
Accounts receivable turnover ratio, vol. | |||
Accounts payable turnover ratio, volume. | |||
Return on equity, vol. |
Indicators of business activity characterize, firstly, the efficiency of use of funds, and secondly, they are of high importance for determining the financial condition, since they reflect the rate of conversion of production assets and accounts receivable into cash, as well as the maturity of accounts payable.
Indicators of business activity presented in table. No. 16, show how many days a particular asset or source of formation of the organization’s property turns over. In general, the calculation uses the formula for the ratio of revenue or cost to an asset.
As can be seen from table No. 16, most turnover indicators increased during the analyzed period. An increase in the turnover period may indicate a negative trend. However, it should also be noted that there is an increase in revenue, which contributes to a decrease in turnover. For the period from December 31, 2006 to December 31, 2007, sales revenue increased by 5.41%.
Business activity indicators (in days) for the entire period under review are presented in Figure No. 4.
Figure No. 4
Clean cycle calculation
The duration of the net cycle is calculated as the difference between the credit and cost cycles and shows how well the financing of production activities is organized at the enterprise.
The duration of the cost cycle is calculated as the total duration of the turnover of current assets, with the exception of the duration of the cash turnover, and shows the time required to carry out the production process.
Thus, the higher the cost cycle turnover value (in days), the more funds the enterprise needs to organize production.
In turn, the duration of turnover of current liabilities is the credit cycle of the enterprise. The longer the credit cycle, the more effectively the company uses the opportunity to finance current activities at the expense of direct participants in the production process.
As can be seen from Table 16, during the analyzed period the duration of the cost cycle increased by 25.62 days. (38.45%), which, other things being equal, may indicate a negative trend that diverts funds into production activities.
The duration of the production cycle during the analyzed period increased by 8.54 days. (2.63%), which may indicate a positive trend and indicate an increase in the efficiency of the enterprise’s use of the opportunity to finance current activities at the expense of direct participants in the production process, if the organization does not create excess debts to suppliers, budget, and personnel.
At the beginning of the analyzed period, the net turnover cycle took -257.61 days. During the analyzed period, the duration of the clean cycle increased by 17.08 days, which indicates a negative trend, since the number of current assets financed by direct participants in the production process has increased, and the financing of production activities is to a greater extent carried out at the expense of those external to the production process - increase in equity capital, loans.
Golden Rule of Economics
When studying the comparative dynamics of absolute indicators of business activity, compliance with the following optimal ratio, called the “golden rule of an organization’s economy”, is assessed:
TRchp > TRv > TRA > 0%, where:
TRchp – growth rate of net profit;
ТРв – growth rate of sales revenue;
TRA – growth rate of average assets.
Fulfillment of the first ratio (net profit grows at a faster pace than revenue) means an increase in profitability of activities (Рд): Рд = PE / В *100
Fulfillment of the second ratio (revenue grows at a faster pace compared to assets) means acceleration of asset turnover (Oa): Oa = B / A * 100
The faster pace of increase in net profit compared to the increase in assets (TRchp > TRA) means an increase in net return on assets (NRA): NRa = PE / A * 100
The fulfillment of the last inequality (an increase in the average value of assets over time) means an expansion of property potential. However, its implementation must be ensured only in the long term. In the short term (within a year), a deviation from this ratio is acceptable if, for example, it is caused by a reduction in accounts receivable or optimization of non-current assets and inventories.
For Rospechat, the formula for the “golden rule of economics” for the analyzed period is as follows:
47.25% > 5.41% > 18.45% > 0%. Thus, at Rospechat the “golden rule of economics” is fulfilled.
An analysis of solvency based on the calculation of net assets is carried out in accordance with the order of the Ministry of Finance of the Russian Federation and the Federal Commission for the Securities Market dated January 1, 2001 N 10н, 03-6/пз “On approval of the Procedure for assessing the value of net assets of joint-stock companies.”
§ The value of net assets is understood as a value determined by subtracting from the amount of assets accepted for calculation the amount of its liabilities accepted for calculation.
§ The assessment of property, funds in settlements and other assets and liabilities is carried out taking into account the requirements of accounting regulations
o current assets reflected in the second section of the balance sheet (inventories, value added tax on acquired assets, accounts receivable, short-term financial investments, cash, other current assets), with the exception of the cost in the amount of actual costs of repurchase of own shares purchased from shareholders for their subsequent resale or cancellation, and the debt of the participants (founders) for contributions to the authorized capital.
§ The liabilities accepted for calculation include:
o long-term liabilities for loans and credits and other long-term liabilities; 5 8
Added: 09/21/2016
Financial planning
Share:
In the process of calculating the turnover of any current asset in the context of total revenue, it is necessary to pay attention to three key indicators:
- asset turnover minus cash;
- turnover of liabilities minus accounts payable;
- the difference between the first and second values.
The first indicator, which is the sum of the turnover periods of all elements of current assets (with the subtraction of cash), is called the cost cycle. The higher its value, the more time the enterprise’s funds are in a “tied” state, the longer it takes to transform them into “new money”.
The name cost cycle can be deciphered quite easily. To carry out production activities, a company has to look for sources of financing for certain costs, including for the formation of reserves. The amount of required financing will increase in proportion to the increase in the period of the cost cycle. In this case, sources of financing can appear directly in the production process, or be attracted from outside. In this case, external sources are considered not only borrowed funds, but also financing through increasing equity capital.
With the growth of the cost cycle, one can state a gradual deterioration in the management of existing working capital and a decrease in the overall efficiency of using the current working capital available to the enterprise. A direct consequence of the increase in the cost cycle is a decrease in the level of return on capital. Accordingly, its reduction will help increase profitability.
Generally speaking, an increase in the cost cycle will inevitably worsen the financial stability of the enterprise. The company will not be able to ensure an increase in current assets without accelerating the increase in liabilities, and in the long term this practice may turn out to be too burdensome.
Practical example. Effective management of working capital.
The company, whose financial indicators are shown in the table below, has been experiencing an increase in the cost cycle over a long period of time. Expected result: the situation with the management of current funds becomes worse and the quality of working capital management decreases somewhat. The deterioration in the manageability of the current assets at the enterprise's disposal is most clearly manifested in the sections of finished products and accumulated receivables: buyers accumulate debts for delivered products, and the share of products ending up in the warehouse has also increased.
Despite maintaining profitability, the company has seen a decline in its return on equity. It is caused by an increase in the period of asset turnover, which in turn influenced the growth of the cost cycle. The company is in dire need of attracting auxiliary financing. To find out whether it is necessary to increase working capital financing from external sources, indicators of short-term liabilities should be analyzed.
| Balance position | 1. IV.2015 | 1. VII.2015 | 1. X.2015 | 1. I.2016 |
| Total current assets | 21 431 | 44 561 | 129 529 | 280 006 |
| 0 | 123 541 | 285 311 | 432 186 | |
| - the same for the period | 0 | 123 541 | 285 311 | 432 186 |
| Cost cycle in days | – | 91,2 | 109,8 | 170,6 |
| – including supplies of materials | 26,8 | 24,1 | 24,9 | |
| – work in progress | – | 4,8 | 2,9 | 2,9 |
| – finished products | – | 17,6 | 20,8 | 25,1 |
| – accounts receivable | – | 3,2 | 40,4 | 107 |
| – other assets (current) | – | 40,2 | 23,1 | 10,2 |
| Return on Equity | – | 12,4% | 27,8% | 26,4% |
Short-term liabilities
When carrying out production activities, enterprises often attract short-term debt obligations related to current liabilities as sources of financing. This category includes the following sources:
- current debts to suppliers;
- current debts to personnel and budget;
- advance payments received.
The concept of sustainable liabilities includes the company's temporary tax arrears and current deferrals in wages. Both types of obligations are due to the periodic nature of tax payments and payroll.
The turnover of each category of short-term liabilities after summation forms the credit cycle. When calculating the credit cycle, the turnover of short-term loans is not taken into account. An increase in the credit cycle indicates a more efficient use of external financial sources in carrying out current activities.
If the credit cycle shows a noticeable increase, the conditions for capital management change towards favorable ones - the number of sources of financing for the needs of the production process increases. However, this statement is correct only if the turnover of each element of current liabilities is at a relatively acceptable level and the enterprise does not have excess debts to the budget, suppliers and personnel.
Practical example. Efficiency of the company's use of short-term liabilities
This example clearly demonstrates the company’s expansion of its credit cycle. The main reason for the growth was the increase in the turnover period of advance payments and accounts payable. The latter arose due to a consistent increase in the average period of deferrals for repayment of invoices from customers, in particular they increased sharply in the last reporting period. The company also increased the amount of advance payments received as prepayments from customers, which allowed it to significantly improve shipment conditions.
| Balance position | 1. IV.2015 | 1. VII.2015 | 1. X.2015 | 1. I.2016 |
| Short-term loans | 0 | 0 | 0 | 0 |
| Total current liabilities | 10 399 | 17 005 | 56 344 | 240 051 |
| Short-term liabilities without loans | ||||
| Total current assets | 21 431 | 44 561 | 129 529 | 280 006 |
| Cumulative total of sales revenue | 0 | 123 541 | 285 311 | 432 186 |
| Credit cycle in days | – | 39,9 | 46,27 | 123,5 |
| – accounts payable | – | 20,3 | 24,1 | 71,2 |
| – settlements with personnel and budget | – | 8,1 | 4,9 | 5,1 |
| – other obligations | – | 9,1 | 20,5 | 49,3 |
| Return on Equity | – | 12,4% | 27,8% | 26,4% |
| Debts to participants on income | 5238 | |||
| revenue of the future periods | 0 | 0 | 0 | |
| Reserves | 1952 | 851 | 1328 | |
| Other short-term liabilities | 0 | 0 | 0 |
If you examine the company's original balance sheet, you will find that the growth of other elements of current liabilities was made possible by the debt to pay dividends to the company's owners. It was debts to the founders that became real financial sources to support production activities in the last period. However, apparently, this debt will be repaid in the next period, and the company's management will have to find another source of financing.
When comparing the dynamic indicators of the credit cycle, we can conclude that its increase was a forced measure, serving to provide current assets with full financing and prevent the occurrence of cash gaps. The increase in delays in payment of invoices by customers was, in turn, offset by delays in settlements with suppliers and other counterparties.
Is the increase in accounts payable a negative or positive trend?
If a company finds itself in a situation where a shortage of working capital threatens to result in cash gaps, accounts payable can significantly improve its financial position. At the same time, resources in the form of direct loans are not attracted and interest servicing costs do not arise, which can definitely be interpreted as a positive circumstance. However, overdue supplier invoices over time can lead to the need to pay fines, penalties, penalties and even lead to the severance of business relations with the counterparty. Therefore, care should be taken to ensure that deferred bills do not turn into chronic non-payments and create problems in the future.
The decrease in the basic liquidity indicator arises not only due to increased accounts payable and its reduction will have almost no effect on liquidity. Since both short-term loans and accounts payable are classified as current liabilities, regardless of which indicator has increased, the result will be identical - a decrease in the total liquidity ratio. Thus, in our last practical example, the company’s liquidity suffered not because of short-term debts, but due to an increase in current assets, which in turn initiated an increase in short-term liabilities.
Clean cycle
If we compare the cost and credit cycles by subtracting the second from the first, we get the so-called clean cycle. This indicator can be characterized as an indicator of the level of production financing.
The clean cycle shows the amount of financing that was carried out not directly by participants in the production process, but from external sources (external, if viewed from the point of view of production) - credit resources and increased equity capital.
An increase in the net cycle almost always indicates a deterioration in the quality of money management. If the net cycle has reached negative values, the accumulated liabilities exceed the required volume of financial support for production and the excess money can be directed to other needs of the enterprise, for example, it can be used to finance non-current assets.
Fluctuations in clean cycle indicators can be interpreted as an indicator of the influence of the quality of working capital management on the need for financial sources by the company's production divisions. The increased need to finance production will be reflected in the growth of the net cycle and will inform the deterioration of management conditions. The decrease in clean cycle indicators can be considered evidence of positive dynamics in management conditions - requests for funding are decreasing and more and more funds are being released from circulation.
It is necessary to distinguish the direct change in the pure cycle from its current value, since the control conditions are affected exclusively by the change in the pure cycle. If its value remains stable and no changes are observed, the enterprise’s need for resources remained at the same level.
Practical example. Relationship between funding requests and working capital management.
Judging by the data from the table, in the first two years the enterprise did not observe a direct impact of management conditions on the need to attract additional financing. A similar conclusion can be drawn from the stable clean cycle indicator for these months. However, in the last period there has been an expansion of financing resources, which appeared due to positive changes in the quality of asset management. This circumstance is indicated by a decrease in the level of the clean cycle from 63 to 47 days.
The data from the last three examples can be interpreted as follows: although the conditions for managing working capital have changed, the financial position of the company is not directly dependent on these changes. If we talk about return on total capital, then there are negative trends, but the absolute value of liquidity has changed in a positive direction.
As mentioned earlier, the next reporting period will be associated with difficulties, due to the fact that the source of financing that appeared due to dividend arrears will be cut off. Since the improvement in working capital management conditions was caused precisely by this debt, the financial position of the enterprise will worsen.
If you look at the data in the last table, an almost threefold increase in the turnover period for current liabilities caused a drop in the net cycle by 30%. If dividend arrears did not arise and the net cycle remained stable, the company would be forced to raise short-term loans to finance production. Covering debt in the next reporting period will cause an increase in the net cycle, and the need for new financial sources will appear.
It is important to find out whether dividend payments will be critical to the financial condition of the company. To do this, you should analyze the financial condition of the company with a study of the total liquidity ratios.
The question often arises: why are short-term loans not included in the credit cycle, although they belong to current liabilities? The answer is quite simple: when calculating the absolute indicator of the clean cycle and analyzing the level of turnover, the problem of identifying the enterprise’s need for external financing is solved, that is, with the use of credit funds. In other words, loans in this situation are not an argument, but the desired value, so their inclusion in the calculation does not make sense.
2.4. Turnover analysis
The purpose of turnover analysis is to assess the ability of an enterprise to generate income through the turnover of Money - Products - Money.
Analysis of turnover makes it possible to supplement studies of the structure of the Balance Sheet on the characteristics of the conditions of material supply that have developed in the organization, the sale of finished products, and the terms of settlements with buyers and suppliers.
Turnover analysis includes:
- analysis of current asset turnover;
- analysis of turnover of current liabilities;
- "pure cycle" analysis.
When analyzing the turnover of an enterprise (organization), indicators are used that are called turnover ratios.
Asset turnover ratio shows how many times the asset in question “turned around” during the period.
Where Active (average)– the average value of the asset under consideration in the period, monetary units.
The average asset value is determined by the formula:
Using the formula presented above, the turnover of the organization's permanent, current and general assets is determined (Table 8, p. 195).
An increase in the turnover ratio over time indicates an increase in the efficiency of using property in terms of generating income (profit). The rate of asset turnover is directly related to profitability indicators.
Analysis of the dynamics of changes in turnover indicators allows us to obtain information characterizing the efficiency of the enterprise. However, the absolute value of the turnover ratio is difficult to interpret.
For example, if during the year the current asset turnover ratio increased from 1.4 to 2, this is a positive trend. However, it is difficult to say whether a value equal to 2 is an optimal, acceptable or critical turnover indicator for an enterprise.
From the point of view of economic interpretation, more informative are the periods of turnover of assets (current and permanent) and current liabilities, which are calculated in days. Of greatest interest is the calculation of the turnover periods of current assets and current liabilities, since it allows us to characterize the principles of managing the organization’s working capital (conditions of material supply, sales, conditions of mutual settlements with buyers and suppliers).
The turnover period of each element of current assets reflects the duration of the period (in days) during which money is “tied up” in a given type of asset. Describing in more detail the process of asset turnover Money – Goods – Money, you can get the picture presented in Figure 9.
During the turnover process, funds go through successive stages. The first stage is advances to suppliers, which are successively converted into inventories, work in progress, finished goods, accounts receivable, and then into new money (for different enterprises, some stages in the presented chain may be missing). Turnover periods provide a time characteristic of each of these stages.
The turnover periods of individual elements of current assets have a real economic interpretation (Table D).
Table D
| Elements of current assets | Economic interpretation of the turnover period |
| Advances to suppliers | Prepayment period for received raw materials and materials |
| Material reserves | Average frequency of materials procurement (renewal of materials in the warehouse). Average duration of storage of materials in warehouse |
| Unfinished production | Average production cycle time |
| Finished products | Frequency of shipment of finished products to customers Average shelf life of finished products in warehouse |
| Accounts receivable (invoices issued) | Average payment period for customers to pay invoices for shipped products. Duration of deferred payments provided to buyers. |
Of economic interest are not only the turnover periods of individual components of current assets, but also their total value.
The sum of the turnover periods of individual elements of current assets, with the exception of cash, constitutes the cost cycle of the enterprise.
The longer the cost cycle, the longer the period of time money is “tied up” in current assets, the more distant the moment of receiving new money (Money).
It is no coincidence that the cost cycle received such a name. Formation of reserves and implementation of expenses requires appropriate sources of financing.
Financing of production activities can be carried out from sources arising from the conduct of production activities and from sources external to the production process.
In this case, external sources of financing mean an increase in the enterprise’s equity capital, attraction of borrowed funds and loans.
Sources of financing arising from production activities are current debt to suppliers (accounts payable), current debt to the budget and personnel, as well as advance payments from buyers. Current debt to the budget (arising due to the established frequency of tax payments) and current arrears of wages (arising due to the frequency of payment accepted in the organization) constitute the organization’s stable liabilities.
To characterize the sources of financing arising from production activities, the turnover periods of elements of current liabilities are calculated (Table 8, p. 195).
The turnover period of each element of current liabilities reflects the length of the period (in days) during which the organization has the ability to dispose of a given source of financing (Table E).
Table E
The sum of the turnover periods of the elements of current liabilities is called the credit cycle of the enterprise.
The above statement is true if the turnover periods of individual components of current liabilities have satisfactory values, that is, the organization does not have (does not create) excess debts to suppliers, the budget, and personnel.
The difference between the cost cycle and the credit cycle is called clean cycle.
The clean cycle is an indicator characterizing the organization of financing production activities. The clean cycle shows the part of the cost cycle that is not financed by participants in the production process (Fig. 9, p. 60).
The larger the net cycle, the less current assets are financed by direct participants in the production process (the more current assets that are financed by sources of financing external to the production process - equity capital gains, loans).
A negative value of the net cycle means that loans from suppliers and buyers more than cover the need for financing the production process and the enterprise can use the resulting “surplus” for other purposes, for example, to finance permanent assets. This situation is the most favorable for the enterprise.
If the negative value of the net cycle is large, we can talk about the risk of failures in repaying accounts payable and fulfilling obligations on advances provided to customers.
Calculation of the turnover periods of elements of current assets and current liabilities is carried out according to the general formula
| Turnover period (T turnover), days = Asset (Liability) (average) / Calculation base (for one day) (8) |
The calculation basis (denominator of Formula 8) is different for different elements of current assets and liabilities (Table F).
Table F
| Elements of current assets (liabilities) | Base for calculating the turnover period (all indicators calculated for the period) |
| Accounts receivable | Revenues from sales |
| Advances from buyers | |
| Cost of sales of products (works and services) + commercial expenses = administrative expenses = Total costs of products sold | |
| Advances to suppliers | |
| Material stocks | Material costs |
| Unfinished production | C/s sales of products (works and services) |
| Finished products | |
| Sustainable Liabilities | Total costs of products sold |
The average value of the elements of current assets and current liabilities is determined according to the aggregated Balance Sheet. Information on sales revenue and costs of products sold is presented in the statement of financial results (Form No. 2).
Note that to calculate turnover periods it is necessary that
- information in Form No. 2 was presented for the period (not on an accrual basis);
- all indicators used in the calculations related to the same time period.
The inventory turnover period (T material inventory turnover, days) is calculated using the formula
Where
Sales cost – cost of sales of products (works, services) in the analyzed period, monetary units. Determined according to the financial results report;
Stock of materials (average) – the average value of stocks of materials in the analyzed period, monetary units. Determined according to the aggregated Balance sheet;
The average amount of inventory is determined by the formula:
(Inventory at the beginning of the period + Inventory at the end of the period)/2
Int – duration of the analyzed period (analysis interval) in days. For example, quarterly reporting corresponds to an analysis interval of 90 days, annual reporting – 360 days.
In order to more accurately determine the turnover period of materials inventories, it is necessary to subtract “inventory-forming” costs from the total costs of products sold. “Inventory-forming” elements include, for example, depreciation charges, wages, and electricity. The purpose of such an adjustment is to estimate the amount of average daily material costs associated with the production of sold products.
When analyzing the principles of inventory management (analysis of inventory turnover), it is advisable to identify the volume of inventory, the value of which can actually be controlled. Unused materials, so-called “dead stocks”, are not renewed (purchased again). For this reason, they should be excluded from the inventory turnover period calculation. That is, the total amount of materials inventories reflected in the aggregated Balance Sheet must be adjusted to the amount of unused inventories (previously purchased and not used in the production process).
Taking into account the adjustment, the formula for calculating the material inventory turnover period is transformed as follows:
Where
Sales cost – cost of sales of products (works, services) in the analyzed period, monetary units;
share of non-Speakers zap. – the share of stocks in the warehouse that are not used in the production process, %. They are sometimes called "dead stocks";
Int – duration of the analyzed period in days;
“Inventory-forming” costs – depreciation, wages, contractor services, energy, depreciation, etc., allocated to sold products of a given period, monetary units;
The calculation of the turnover period of materials inventories can be carried out without adjusting for the amount of depreciation charges and wages. The calculation result is correct, but it must be remembered that the actual turnover period will be slightly longer.
Businesses that have a small percentage of unused inventory can ignore the adjustment factor, denoted as [*(1-proportion of unused inventory)].
The turnover period of work in progress (T turnover of work in progress, days) and finished products (T turnover of finished products and goods) are calculated using similar formulas
The average value of work in progress and finished goods in each of the analysis intervals is determined according to the data of the aggregated Balance Sheet.
If the Balance Sheet of the enterprise takes into account “frozen” work in progress and finished products in significant volumes, it is necessary to supplement the numerators of the formulas with factors (1-share of “frozen” work in progress) and (1-share of “frozen” finished products in the warehouse).
“Frozen” in this case refers to work in progress and finished products related to products that are currently discontinued.
When determining the turnover period for materials inventories, commercial and administrative expenses are not included in the calculations, since in most cases these expenses are not “inventory-forming” (they do not form material inventories). From the point of view of payment, administrative and commercial expenses are equivalent to other costs, and therefore must be taken into account when calculating the period of turnover of accounts payable and advances to suppliers (denoted as T turnover of accounts payable and T turnover of advances to suppliers, respectively).
Where
Total sales costs - the total amount of sales of products, commercial and administrative expenses in the analyzed period, monetary units
Int – duration of the analyzed period (analysis interval) in days.
The average amount of advances to suppliers and accounts payable is determined according to the aggregated Balance Sheet. The average value is calculated using the formula (Value at the beginning of the analysis period + Value at the end of the analysis period)/2.
Calculation of the turnover periods of advances to suppliers and accounts payable can be performed without adjusting for the amount of depreciation charges and wages. The calculation result is correct, but it must be remembered that the actual turnover period will be slightly longer.
where Revenue from sales (for the period) is the amount of revenue from sales of products (works, services) received in a given analysis interval, denominated. units Determined according to the financial results report;
Int – duration of the analyzed period (analysis interval) in days;
The average amount of advances from buyers and receivables is determined according to the aggregated Balance Sheet. The average value is calculated using the formula (Value at the beginning of the analysis period + Value at the end of the analysis period)/2.
If the accounts receivable contains a significant share of bad receivables, it is necessary to exclude them from the calculation of the invoice turnover period. The purpose of such an adjustment is to estimate the real value of the “revolving” debt.
where is the share of hopelessness? DZ – the share of bad debts (the probability of which is close to zero) in the total amount of accounts receivable for a given period, %.
The periods of turnover of debts to the budget and wages (the period of turnover of stable liabilities) are combined in the period of turnover of other current liabilities. Its value can be determined expertly, taking into account the frequency of payment of taxes and wages (direct formula calculation using data from the Balance Sheet and Form No. 2 is difficult).
Interpretation of the turnover period of other current assets is difficult, since the position “Other current assets” combines elements that are heterogeneous in their economic meaning. The turnover period of other current assets is determined similarly to the turnover period of inventories (the numerator of the formula reflects the average value of other current assets).
When calculating the turnover periods of receivables and payables, advances from buyers and advances to suppliers, the amounts of cash payments must be excluded from the total amount of sales revenue and costs of selling products. Such an adjustment is necessary for organizations where a significant share of payments are made in cash.
The influence of working capital on the financial condition of the organization can be represented in the form of a diagram:
It should be noted that changes in absolute liquidity are affected by changes in working capital (not an absolute value). In this case, a change in working capital leads to a one-time change in absolute liquidity.
