OPERATING CYCLE
Operating cycle for an organization is defined as the average time duration which it takes to bring back capital invested in its business operations to its cash accounts. Operating cycle period varies from business to business.
For a manufacturing business, it would be the average time that the company takes to procure raw materials, manufacture & sell finished goods and receive cash from the sale of goods.
For a trading/reseller business, the operating cycle calculations will not include activities like raw material procurement & production of finished goods – it will be simply the duration starting from the procurement of goods (cash outflow) to point where revenue is received from the customer.
Companies prefer to maintain short operating cycles as it enables them to require less cash to maintain its operations and thus can grow with relatively small business margins as well. On the other hand, companies with unusually long operating cycle may require additional funds to grow at a modest pace even with fat margins.
Example. To illustrate, consider the below reseller/ trading business scenario:
- The company uses cash to purchase inventory items
- It takes on average 90 days to get the items sold
- In general, the company offers a 30 days’ credit period to all its customers
- The company receives the money from these customers on average of 45 days after the sales occurred (irrespective of the 30 days’ credit period)
Operating cycle for such a reseller business can be calculated to be 135 days, as illustrated below:
Familiarity with the concepts of operating cycle is necessary for a better understanding of working capital, current assets and current liabilities.
Table of Contents : Accounting Principles
Accounting Principles & guidelines