Exploitation Cycle and Working Capital Management
Exploitation Cycle: All companies need monetary resources to acquire productive factors for their operations. Until products are sold, expenses (salaries, maintenance, advertising, etc.) must be covered. The exploitation cycle is the time from asset acquisition to cost recovery through depreciation. A shorter cycle, from raw material acquisition to product sale, is also considered. This is called the exploitation cycle, and its average duration is the average maturity period (PMME), usually calculated in days.
PMME = Storage days + Production days + Sales days + Collection days
PMME = dp + wp + sd + cd
Raw materials are purchased from suppliers who must be paid. Ideally, payment days to suppliers exceed PMME, as this means suppliers are providing financing. If not, the company must finance the difference (with equity, loans, etc.).
The portion of PMME not financed by suppliers is the cash or financial maturity period (PMMF): PMMF = PMME – Payment days to suppliers. A shorter cash cycle is preferable, indicating that suppliers finance a larger part of the process. In commercial companies (without manufacturing), PMME calculation differs, as there are no raw material storage or production sub-periods.
BLOCK 2: THE ROLE OF COMPANY FINANCE: This department is responsible for obtaining resources for company investments (a passive role).
Synonym asset investments
Synonym funding liabilities
Working Capital Required (Minimum Circulating Capital)
Calculating PMME and PMMF helps determine the minimum circulating capital needed. If suppliers don’t finance the entire PMME, the company needs funding to cover expenses before sales. This funding can come from creditors, equity, or loans.
Working capital required (WCR) is the sum of money needed to finance PMME. NOTE: WCR differs from Financial Maturity (FM):
- Calculation:
- FM: Current Assets – Current Liabilities
- WCR: Financing cost of storage + Financing cost of production
- Interpretation:
- FM: Analyzes company financial equilibrium.
- WCR: Analyzes supply, billing, and payment issues.
If FM < WCR: The company faces potential liquidity problems. If FM > WCR: There’s excess FM, possibly indicating low asset profitability. If FM = WCR (+ or -): Equilibrium exists, indicating the company’s needs match its resources.
Possible Actions to Improve PMME Management
- To shorten the raw material storage sub-period, improve inventory control. Minimum safety stock levels prevent production delays, which lengthen PMME.
- To shorten the production sub-period, increase productivity through employee incentives or process engineering improvements.
- To shorten the sales sub-period, offer sales promotions.
- To shorten the billing sub-period, offer customer discounts (e.g., volume discounts for immediate payment).
- To shorten PMME, negotiate better delivery deadlines and discounts with suppliers.