Operating Cycle, Cash Management & Economic Order Quantity (EOQ)

Explanation

Working capital management navigates the trade-off between profitability and liquidity. Holding excess current assets reduces insolvency risk but depresses return on assets; maintaining low working capital enhances profitability but exposes the enterprise to production halts and liquidity default.

Key points

• Operating Cycle: Time between purchasing raw materials and receiving cash from debtors: OC = Inventory Period + Debtors Period.
• Cash Conversion Cycle (CCC): CCC = Operating Cycle - Creditors Payment Period.
• Financing Policies: Matching / Hedging (mature matching), Conservative (long-term funds finance permanent and part of temporary CA), Aggressive (short-term funds finance temporary and part of permanent CA).
• Inventory Management: EOQ = √[(2 · Annual Demand · Ordering Cost) / Holding Cost per unit].

Example

Code examples

// Economic Order Quantity (EOQ) Calculation in C++
#include <iostream>
#include <cmath>
using namespace std;

int main() {
    double D = 10000; // Annual demand in units
    double S = 250;   // Ordering cost per order
    double H = 5;     // Carrying/holding cost per unit per year

    double eoq = sqrt((2 * D * S) / H);
    double totalOrders = D / eoq;
    double totalCost = sqrt(2 * D * S * H);

    cout << "Economic Order Quantity (EOQ): " << eoq << " units" << endl;
    cout << "Optimal Number of Orders per Year: " << totalOrders << endl;
    cout << "Total Inventory Carrying & Ordering Cost: NPR " << totalCost << endl;
    return 0;
}

Exam questions

• [8 Marks] Explain the components of Working Capital. Calculate the Cash Conversion Cycle for a firm given relevant turnover figures.
• [7 Marks] Derive the EOQ formula. Given Annual Demand = 8,000 units, Ordering Cost = NPR 200, Carrying Cost = NPR 2/unit, calculate EOQ.