The Operating cycle definition establishes how many days it takes to turn purchases of inventory into cash receipts from its eventual sale. It is also known as cash operating cycle, cash conversion cycle, or asset conversion cycle. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days. These come together to form the complete measurement of operating cycle days. The operating cycle formula and operating cycle analysis stems logically from these.
The payable turnover days are the period of time in which a company keeps track of how quickly they can pay off their financial obligations to suppliers. Inventory turnover is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, calculate this ratio by dividing the overall sales by the overall inventory. However, you can also calculate the ratio by dividing COGS by the average inventory. Finally, the accounts receivable turnover days is the period of time the company is evaluated on how fast they can receive payments for their sales. In conclusion, the operating cycle is complete when you put together all of these steps.
The operating cycle concept indicates a company’s true liquidity. By tracking the historical record of the operating cycle of a company and comparing it to its peers in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable. This is because a company realizes its profits quickly. Thus, it allows a company to quickly acquire cash to use for reinvestment. A long business operating cycle means it takes longer time for a company to turn purchases into cash through sales.
In general, the shorter the cycle, the better a company is. Tie up less time capital in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. Try to shorten each of the three cycle sections by a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle. Thus, it can consequently lead to a more successful business.
Operating Cycle Analysis