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4.2 Working Capital And Cash Conversion Cycle

The difference between current assets and current liabilities is known as net working

Capital. Usually current assets exceed current liabilities- that is, firms havePositive working capital.

The following figure explains a simple cash conversion cycle. From the point cash is spent to buy inventory, then processed to convert it into finished goods and converted into receivables, which when realised gives us again cash.

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Cash conversion cycle = (inventory period + receivables period) – accounts payable period

The longer the production process, the more cash the firm must keep blocked up in inventories. Similarly, the longer it takes customers to pay their bills, the higher the value of accounts receivable. So the firms must try and reduce the period so that the cash conversion cycle can be reduced, thus requiring less amount of working capital in the business.

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