What Is the Operating Cycle and How to Calculate it? Unlock Your Business’s Financial Health

The operating cycle is a critical concept within the realm of business management that reveals how effectively a company transforms its inventory into cash. The operating cycle (OC) differs from the cash conversion cycle (CCC) in that the OC does not allow for the accounts payable payment period. The OC measures the time difference between the purchase of fixed assets inventory and the collection of cash unlike the CCC which measures the time difference between the payment for inventory and the collection of cash.

Pharmaceutical Company

Mitigate credit risk, reduce bad debt, and streamline customer onboarding with AI-powered insights. The operating cycle is equal to the sum of DIO and DSO, which comes out to 150 days in our modeling exercise. So, from the above-given data, we will calculate company XYZ’s Inventory Period (days). Working capital is the amount of available capital that your company can use for day-to-day operations.

Key Differences:

• HighRadius seamlessly integrates with leading ERPs like SAP and Oracle, ensuring a smooth and comprehensive O2C process.
• You don’t want to make your customers pay so quickly that they buy from someone else with less aggressive collection policies.
• Initiation of the cycle involves sourcing essential raw materials required for production.
• It might seem like an academic exercise, but understanding the operating cycle holds genuine value for any business.
• As illustrated above, the start of the cycle involves purchasing the raw material to create the product.
• As such, understanding the operating cycle can be instrumental in predicting potential cash flow issues and assessing operational efficiency.
• Once businesses master this, they can better navigate the financial seas – a victory for all stakeholders.

Next, calculate accounts receivable days by dividing average accounts receivable by net credit sales, followed by multiplying this result by 365. As shown above on average there are 105 days between buying inventory and receiving cash from the sale of that inventory. As can be seen the Budgeting for Nonprofits longer the inventory holding period and the longer the time it takes customers to pay, the longer the operating cycle of the business will be. An operating cycle is crucial since it can show a firm’s owners how fast they can sell the stock. A shorter operating cycle, for instance, indicates that the business was capable of turning around rather rapidly.

Importance of the Operating Cycle in Business

HighRadius stands out as an IDC MarketScape Leader for AR Automation Software, serving both large and midsized businesses. The IDC report highlights HighRadius’ integration of machine learning across its AR products, enhancing payment matching, credit management, and cash forecasting capabilities. The Operating Cycle tracks the number of days between the initial date of inventory purchase and the receipt of cash payment from customer credit purchases. Below is a snip of Walmart’s balance sheet where we can find the inventories, receivables, and accounts payable amounts. Both formulas are liquidity measures and can also be used as a gauge for the operational and financial effectiveness of a company. Master the skills to connect with customers confidently, understand their needs, and make each sale a success.

• Businesses with physical inventories generally have longer operating cycles than service companies.
• Accelerate payment recovery from delinquent customers and boost cash flow through automated collection workflows.
• An effective way to shorten your operating cycle is to calculate the number of working days required to sell off the inventory.
• For instance, for the retail industry, it may be short, while for the manufacturing industry, it might be longer due to production times.
• This longer cycle requires careful cash flow planning, especially in export-heavy industries where delays in foreign payments are common.

In service-based businesses, such as software firms, the operating cycle revolves around time and manpower rather than physical goods. For example, a software company may take 3 to 6 months to develop a product for a client. After completion, an invoice is raised, and the client may take another 30–60 days to operating cycle pay. Once you understand the components of the operating cycle, the next step is optimising it to support sustainable business growth. Here are proven strategies to reduce cycle duration and strengthen financial control.

The raw materials are processed and converted to finished goods which are sold to customers. The number of days it takes a company to sell the inventories is called days inventories outstanding. Inventories are predominantly sold on credit which means the company must wait a certain number of days till it receives cash from customers.