Operating Cycle Analysis
Operating Cycle Definition
The Operating cycle definition, also known as cash operating cycle or cash conversion cycle or asset conversion cycle, establishes how many days it takes for a company to turn purchases of inventory into cash receipts from its eventual sale. 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. To be more specific, 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. The next step, inventory turnover, is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, this ratio is calculated by taking the overall sales and dividing it by the overall inventory. However, the ratio can also be calculated by taking the cost of goods sold and dividing it by the average inventory. The final step, the accounts receivable turnover days, encase the period of time in which the company is evaluated on how fast they can receive payments for their sales. As said before, when all of these steps are put together the operating cycle is complete
Operating Cycle Applications
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 peer groups in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable since a company realizes its profits quickly and allows a company to quickly acquire cash that can be used 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 since less time capital is tied up in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. The easiest way to do this is to try to shorten each of the three cycle sections by, at least, a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle which can consequently lead to a more successful business.