Working capital cycle refers to period that elapses between the payment for raw materials bought on credit (cash outflows) and the receipts of cash from finished goods sold on credit (cash inflows).

The working capital cycle will involve the following:

a)    Purchase of raw materials on credit from suppliers
b)    Payment of raw materials after the lapse of credit period
c)    Conversion of raw materials into finished goods
d)    Sale of finished goods to creditors
e)    Receipt of cash from debtors.

This can be illustrated using a diagram as follows:

    Raw material stock conversion period

      Creditors Payment Period                           Debtors Collection Period
    A                      B        C                  D
Purchase of            Payment of        Finished goods            Receipts of
Raw materials            raw materials        sold on credit            cash goods
On credit            cash outflow                        sold on credit
                                           Cash inflows

                            Working Capital Cycle
Working capital cycle    =    Stock conversion + debtors collection – Creditors payment

From the diagram the working capital cycle of a period will be determined as follows:

Stock conversion period + Debtors collection period – Creditors payment period

A lengthy working capital cycle is an indicator of poor management of stock and debtors reflecting low turnover of stock and debtors and lengthy stockholding period and debtors collection period.

The working capital cycle can be reduced in any of the following ways:

1.    Negotiate for a longer credit period with the suppliers
2.    Reduce the stock conversion period or manufacturing period.
3.    Reduce the debtors collection period by granting short crediting period.  This can be achieved through offering discounts to customers to encourage them to pay earlier.
4.    Holding fast moving goods to ensure high turnover.
5.    Timely delivery of raw materials by suppliers especially if any delay in delivery will lengthen the raw materials holding period.
3.    Gearing/Leverage/Capital Structure Ratio

The ratio indicate the extent in which the firm has borrowed fixed charge capital to finance the acquisition of the assets or resources of the firm.
The two basic gearing ratios are:

a)        Debt/equity ratio    =    Fixed charge capital
                        Equity (net worth)

This ratio indicate the amount of fixed charge capital in the capital structure of the firm for every one shilling of owners capital or equity e.g a ratio of 0.78 means for every Sh.1 of equity there is Sh.0.78 fixed charge capital.

         b)                Fixed charge to total capital ratio    =      Fixed charge capital    x 100
                                       Total capital employed

Where total capital employed = Fixed charge capital + equity relative to total capital employed by the firm e.g a ratio of 0.38 means that, 38% of the capital employed is fixed charge capital.