The financial cycle is the period that is concluded between the date of repayment of accounts payable (payment by buyers of received materials and raw materials from suppliers) and the date of repayment of accounts receivable (receipt of funds from buyers for products received by them). The second name of this concept is the cash cycle.
The financial cycle has a duration defined by the following formula:
PFC = POPZ + PODZ - POSZ,
where POPZ - the period of circulation of inventories;
PODZ - an indicator of the period of circulation of receivables ;
POPZ - an indicator of the period of circulation of accounts payable.
Based on the foregoing, the duration of the cash cycle is characterized by the average duration associated with the outflow of funds during the implementation of the main production activities, and the inflow as a result of production and financial activities.
In other words, the financial cycle is the time for which money is diverted from circulation. This indicator is necessary in determining the effectiveness of economic activity of the subject.
The company always has at its disposal a reserve, which it can use if necessary. We are talking about cash resources represented by accounts payable. Indeed, money invested in production cannot simply be taken from there to cover their short-term shortage. Therefore, we are not talking about sales of inventories at low prices. The situation with receivables is similar. To obtain additional funds, the business entity is seeking certain changes in relations with debtors.
The financial cycle of the enterprise shows the effective regulation of the same payables. So, the moment of payment can be successfully managed, and in the event of a critical situation - to delay the repayment of such debt. In other words, it is payables that indirectly regulate the volume of current cash and should be taken into account when evaluating the financial activities of the company.
When conducting an analysis of the subject’s activities, specialists note the interconnection of the operational and financial cycles, but at the same time they describe various aspects of the enterprise’s functioning. So, with the help of the operating cycle, the production and technological aspects of the company’s activities are described . It shows the time at which financial resources are frozen in the form of stocks and receivables.
The financial cycle shows exactly the financial aspect of the activity. Due to payment of bills, an enterprise has a certain time lag - the time for which monetary resources are extracted from the turnover is less than the average indicator of accounts payable turnover.
With the dynamic reduction of the operational and financial cycles by specialists, this fact is regarded as a positive trend. The reduction in the size of the operating cycle is carried out mainly by increasing the speed of the production process and accelerating the turnover of receivables. And the financial cycle can be reduced due to some decrease in accounts payable turnover.