What is the operating cycle?

The time between the purchase of an asset and its sale , or the sale of a product made from the asset

 

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It is an indicator of management performance efficiency, it`s a twin of the cash conversation cycle

- In the operating cycle receivables, inventory and payables are analyzed from the orespective of how well the company is managing these critical operational capital assets, as opposed to their on cash

The operating cycle is also known as the cash conversion cycle. In the context of a manufacturer the operating cycle has been described as the amount of time that it takes for a manufacturer's cash to be converted into products plus the time it takes for those products to be sold and turned back into cash. In other words, the manufacturer's operating cycle involves:

- paying for the raw materials needed in its products

- paying for the labor and overhead costs needed to convert the raw materials into products

- holding the finished products in inventory until they are sold

- waiting for the customers' cash payments for the products that have been sold

Some calculate the operating cycle to be the sum of:

- the days' sales in inventory (365 days/inventory turnover ratio), plus

- the average collection period (365 days/accounts receivable turnover ratio)

The above sum is sometimes reduced by the number of days in the credit terms of the accounts payable.

 

The operating cycle has importance in classifying current assets and current liabilities. While most manufacturers have operating cycles of several months, a few industries require very long processing times. This could result in an operating cycle that is longer than one year. To accommodate those industries, the accountants' definitions of current assets and current liabilities include the following phrase: ...within one year or within the operating cycle, whichever is longer.

 

To assist you in computing and understanding accounting ratios, we developed 24 forms that are available as part of AccountingCoach PRO. 

 

You can also read our Explanation of Financial Ratios.

The net period required for activities,"making initial expenditures on purchase of material/saleable goods, manufacturing, storing and ultimately selling and collecting revenues".

The operating cycle is the average period of time required for a business to make an initial outlay of cash to produce goods, sell the goods, and receive cash from customers in exchange for the goods. ... Longer payment terms shorten the operating cycle, since the company can delay paying out cash.