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Hello sir John hope you are doing alright? why the faster the working capital cycle turn why do we need less working capital funding?
let me rephrase the question sir, why the Quicker the operating cycle less amount of investment in working capital is needed and why it improves the profitability. ?
One way of reducing the operating cycle is to collect receivables faster. If that happens then the level of receivables will be lower. The same happens with inventory. If receivables and inventories are lower then the working capital overall will be lower and therefore less investment is needed.
If less investment is needed in working capital then there is less interest cost involved and therefore profits will be higher. (In addition, collecting receivables faster means less chance of irrecoverable debts, and lower inventories means less chance of inventory becoming obsolete – both of these means less expense and therefore more profits.)
Sir if we were to collect the receivables faster wouldn’t this improve our liquidity so lower the working cycle days higher the liquidity? but if there is lower working capital cycle then lower investment in working capital so lower liquidity doesnot this contradict each other?
Liquidity is a measure of how easily the company is able to pay it’s bills. The current ratio and the acid test ratio are to measures of this. However they are ratios – it is not the overall level of working capital that matters.