The operating cycle pertains to a company’s inventory turnover and payment for goods and services.
All your business assets are converted into products/services/cash and back.
It calculates accounts receivable turnover, inventory turnover, average collection and payment periods.
Companies’ loan interest rates and ability to finance new growth projects depend on their operational cycle duration.
Why Operating Cycle Matters
Operating cycle is crucial for several reasons.
Company cash flow is affected by operating cycle duration. Longer cycles give companies more time to pay debts and less time to earn revenue.
This might strain a company’s budget and make it hard to invest in new projects or grow.
Second, a company’s operational cycle might affect profitability. The longer the cycle, the longer a corporation has to discount its items to recoup its costs.
This reduces profits and a company’s ability to invest in expansion.
The operating cycle also affects a company’s creditor connections.
The longer the cycle, the more likely a corporation will default on debt. This may raise interest rates and costs and affect a company’s credit rating.
Related to a Company’s Financial Health
The operating cycle helps assess a company’s finances.
It can indicate how efficiently management uses assets, which affects capital intensity, fixed overhead turnover, and return on investment.
It also indicates a company’s cash usage time. Thus, the operational cycle indicates a company’s liquidity and solvency.
From a bigger viewpoint, the operational cycle affects a company’s financial health by estimating its operating costs and debt-paying speed.
Calculating Operating Cycle
Inventory and accounts receivable periods are included to create the Operating Cycle.
Operating Cycle = Inventory + AR
Where: Inventory Period = days to sell inventory.
Divide 365 by cost of goods sold/average inventory or inventory turnover.
365 / (Cost of Goods Sold / Average Inventory)
Accounts Receivable Period is the amount of days it takes to get paid for goods and services.
Divide 365 by credit sales/average accounts receivable or receivable return.
The detailed Operating Cycle calculation is:
Cost of Goods Sold / Average Inventory + Credits Sales / Average Accounts Receivable = Operating Cycle.
Operating Cycle Improvements for Your Company
Business owners should examine accounts receivable turnover, average payment period (inventory days), and inventory turnover to enhance operations.
Reducing the number of times customers must pay for a product before buying another and the number of days between buying raw materials and selling finished goods can help enhance the operating cycle.
Other operating cycle improvements include:
Managing cash and credit better
Keeping accounts receivable, inventory, and payable balances correct and current
Payment for goods and services on time
A corporation can improve cash management and cut costs by streamlining the operation cycle.
Why the Operating Cycle Matters to Marketing and Finance
Marketing, finance, and other expenditures can be reduced by effective operations.
Net accounts receivable turnover determines how often clients must pay for their product before buying again.
You can then select how much time and resources to devote to bad debt collection. Finance is affected by operational efficiency since it affects cash flow and inventory.
An efficient account receivable days period can lower the amount of outstanding bills, making it easier for a business owner to estimate cash receipts and expenses for each accounting period.
High inventory turnover can also indicate efficient operations, which boost shareholder value.
Effective Business Operations Processes Are Crucial
An effective operational procedure boosts cash flow, which benefits other business factors.
An efficient sales team may boost market share and speed up customer acquisition.
Meanwhile, an efficient production process can boost product quality, turnover, and reduce manufacturing errors.
Inventory, accounts receivable, non-selling expenses (general administration), payroll overhead, and other costs can be reduced by operational efficiency.
This leaves more money for shareholder value or corporate reinvestment.
Companies with High or Low Operational Efficiency
High-efficiency enterprises sell short-lived goods and services like apparel and gadgets.
These things are mass-produced and need little inventory. Wal-Mart and Costco can rotate their inventory roughly five times a year.
Companies that sell items or services with longer lifespans or less inventories are less efficient operationally.
Airlines use expensive aircraft and work around the clock, therefore they have longer cycles.
The Verdict
Capitalizing on operational efficiency can benefit your entire firm.
Thus, operational process optimization can lower costs, boost speed, and boost quality, which may boost profitability.
Inventory, accounts receivable, non-selling expenses (general administration), payroll overhead, and other costs can be reduced by operational efficiency.
This leaves more money for shareholder value or corporate reinvestment.
An effective operational procedure boosts cash flow, which benefits other business factors.
High-efficiency enterprises sell short-lived goods and services like apparel and gadgets.
These things are mass-produced and need little inventory.
Companies that sell items or services with longer lifespans or less inventories are less efficient operationally.