January 29, 2022

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Meaning Raw Material Conversion Period and Key Explanations

Meaning Raw Material Conversion Period and Key Explanations
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In this article, let’s explain an aspect of the operating cycle. The raw material conversion period measures the duration in which raw materials are converted to work in progress and finished goods. Here, let’s discuss the details and also the impact of it on profit.

Meaning of Raw Material Conversion Period

1. It is the period it takes to buy raw materials and convert them to work in progress or finished goods.
2. Also, you can define it as the time it takes for using stocks and converting the same to work in progress or finished goods.

Key Explanations

Raw materials. These are any items required to create a product. In making bread, for example, flour, sugar, butter, salt, water, and other ingredients form part of the raw materials. The raw materials will be processed together to form finished goods. In many cases, all raw materials may be processed before the end of the accounting period. This leads to a work in progress.

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Operating cycle. The raw material conversion period is one of the elements used to calculate a business operating cycle. In addition, included in the calculation of the business as a manufacturing firm.

Formular. The formula is:

Raw Material Conversion period = (Average raw materials ÷ Cost of raw materials Consumed for the period) × 365 days/52 weeks/ 12 months

Average raw materials = (opening + closing raw materials) ÷ 2

The use of days, weeks, or months depends on the user of the formula and the purpose of its use.

Example of Raw Material Conversion Period

The table below is of Honeywell PLC, a company in Nigeria. The abstract is from the 2020 annual report. From the data below, the raw material conversion period will be calculated.

From the formula above, the first step is to calculate the average raw materials:

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The average raw materials

= (1323078 + 4627292) ÷ 2
This gives, 2,975,185

Next, the Raw materials Conversion period
= 2,975,185 ÷ 57,236,117
Next,
=0.052 × 365 days
This gives, 18.97 days

Impact of Raw Material Conversion Period

The conversion periods of raw materials affect profit. A longer period will lead to less profit. Furthermore, a shorter period will lead to more profit. A longer period means that the company will have a high cost of raw material consumed. This will reduce the profit. Also, a shorter period shows that the entity reduced its cost of raw materials used. Therefore, resulting in more profit.

A problem with this is when the entity has a huge finished goods inventory. That is, upon faster conversion of raw materials to finished goods, the business fails to put up its marketing strength to sell the goods.

Conclusion

Finally, the raw material conversion period arises from the duration it takes to purchase materials and the process of using them to make products. The faster raw materials are consumed the more profit a company may have. However, the exception to this is when the company is not making more sales, leading to the high cost of finished inventory.

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