The working capital cycle of a firm can be defined as the length of time between the acquisition of raw materials and other inputs,and the inflow of cash into the business from the sale of goods.
The cycle starts with investment in raw materials, which are then used in the production process and thereby become work in progress. Eventually, these become finished goods which are held in stock until sold. Some of these goods are sold for cash and others are sold on credit, with the customer paying after a certain period. At each stage of the process, expenditure is necessary on labour and other operational inputs, which puts pressure on the financial resources of the firm. However, just as we finance our debtors by allowing them some time between date of sale and date of payment, our suppliers who sell to us on credit also finance us to a certain extent (in the sense that if we had to pay them immediately we would need more cash resources).
Money tied up in any stage in the working capital chain has an opportunity cost. In addition, there are costs associated with storage and administration. The combined costs can be considerable, and it is the duty of the financial manager to arrange the affairs of the business in such a way as to obtain a balance between the costs and benefits involved. Amounts invested in working capital is about 80 per cent of the amount invested in fixed assets. The size and significance of this working capital investment means that the success of an organisation may depend heavily on the implementation of a wise working capital policy.