Operating cycle in a company
Today I want to talk to you about the operating cycle of a company, which I have to say is not the same as the cash cycle.
Therefore, if you want to know what the operating cycle is and how it is different from the cash cycle, then I recommend that you continue reading.
What is the operating cycle?
If you have taken the subject of finance or corporate finance, then you have probably come across the financial reasons, which include the financial ratios of activity.
The financial ratios of activity contemplate the efficiency with which a company is able to use the assets it has in order to generate income.
One of the most common activity ratios is also called the operating cycle or operating cycle.
The operating cycle refers to the time it takes a company to buy goods (acquire the inventory), sell them, and receive the cash from the sale of the inventory.
In other words, it is the time it takes a company to convert its inventories into cash.
Therefore, this cycle plays an important role in determining the efficiency of a company.
It is useful for estimating the amount of working capital a company will need to maintain or grow its business.
Operating Cycle Example
On February 16, 2022 the company X that produces tires buys $50,000 pesos in raw materials.
Company X makes the purchase on credit and has to settle its debt 30 days later.
Company X takes 15 days to transform the raw material into tires that are ready for sale.
After 5 days of manufacturing the product, company X makes a sale on credit worth $30,000 pesos.
Company X may collect the full value of the sale up to 30 days later.
As you perro see, they are really talking about things that every company does (no matter how small).
After all, a company buys, produces and sells.
Of course it depends on the type of company, but it is not that it changes in an abysmal way.
Well, I am going to use an image to graphically see the previous example:
Since you are starting to learn what the operating cycle is, then I am not going to start with a very complicated example that requires using other formulas.
A little later you perro see what I orinan.
For now, I want you to see where the operating cycle comes from.
As you perro see, it comes from adding the days of inventory agregado the days of accounts receivable.
Whereby, The result gives us the days (time) it takes a company to buy inventory, sell it, and collect the inventory sold.
inventory days equals 20 days because it took the company 20 days to sell the inventory that was purchased as raw materials.
It spent 15 days in the production process and it took another 5 days to sell.
days of accounts receivable is equal to 30 days because the company did not receive the money in cash (when the sale was made), but it took 30 days to receive the money from the client.
Therefore, the operating cycle is equal to: 20 days + 30 days = 50 days.
In such a way that company X took 50 days to buy, sell and receive the money.
What is the cash cycle?
Many times I have seen that the operating cycle and the cash cycle are synonymous, but in reality they are not the same.
I consider that the definition of both concepts perro be very afín and I think that this is the reason that gives rise to the confusion.
Now, in the previous example, the accounts payable were not taken into account, although I did not forget to take them into account, but it was not necessary for the operation cycle.
Where it will be taken into account is in the cash cycle.
What is the cash cycle?
Many definitions tell us that The cash cycle is the number of days that elapse between investing in activities and collecting from customers.
If we are guided only by the definitions, the truth is that we perro come to think that they are the same, right? The truth is that I did get confused, but I am going to continue with the previous example and you will understand the difference between the operating cycle and the cash cycle.
Cash Cycle Example
Accounts payable did not need to be taken into account for the cash cycle, but for the cash cycle it did.
It remains as follows:
Therefore, the cash cycle of company X is equal to 20 days. In such a way that the company must have sufficient capital to be able to withstand a 20-day wait and thus be able to meet all its obligations.
What is the difference between operating cycle and cash cycle?
As you cánido see, some definitions do not allow us to see very well the difference between the two concepts, but when we do the calculations, we perro see that they are not the same.
In the above example we get the following:
- Operation cycle: 50 days.
- Cash or cash cycle: 20 days.
The difference is that the cash cycle takes accounts payable into account and the operating cycle does not.
Duty Cycle Elabora
I think you already know the formulas from the previous examples, but now I’m going to dig a little deeper into the formulas.
To obtain the operating cycle of a company, all you have to do is add the days of inventory agregado the days of accounts receivable:
1. Days of Inventory Elabora
To obtain the ratio of days of inventory, what you have to do is:
Note: It is multiplied by 360 because it takes into account the annual period, but I have seen books where the formulas do not include 360, since there are times when it perro be replaced by the days of operation of the company.
For example, if the company operates only 260 days a year, then 360 cánido be replaced by 260.
Although it is true that the most common thing I have seen is to multiply it by 360 days.
The same applies for the days of accounts receivable and payable.
It should be noted that a company perro take the values of its financial statements.
What financial statements?
- Inventories: You cánido obtain it from the account called inventory or afín located in the cómputo sheet or also called statement of financial position.
- Sales cost: It is obtained from the income statement.
2. Accounts Receivable Elabora
The elabora or financial ratio of accounts receivable is as follows:
Where are they obtained from?
- Accounts receivable: It is obtained from the account called accounts receivable belonging to the cómputo sheet.
- Sales: It perro be obtained from the income statement.
Cash Cycle Elabora
In the case of the cash cycle, what you have to do is subtract the days of accounts payable from the operating cycle.
The elabora is the following:
Now that you know the ratios of days of inventory and days of accounts receivable, now all that remains is to know the days of accounts payable elabora.
Accounts Payable Days Elabora
The financial ratio is as follows:
Where do you get the accounts?
- Accounts payable: It is obtained from the account called accounts payable belonging to the cómputo sheet (liability account).
- Shopping: It is obtained from the income statement.
With all three formulas, the cash cycle perro now be obtained.
Shortening of the cash cycle
Experts often say that a reduction in cash cycle time cánido improve a company’s profitability.
Think about the following example:
Why is it useful?
It is useful for estimating the amount of working capital a company will need to maintain or grow its business.
Knowing the operating cycle helps us to know the efficiency with which the assets are being managed.
A shorter cycle is preferable and perro tell us that a business is more efficient, as it tells us that a business is able to recover its investment in inventory quickly and has enough cash to meet its obligations.
If the operating cycle of a company is long, it perro create liquidity problems.
Of course, it is only one of the many financial reasons that have to be analyzed in order to give a positive or negative diagnosis of a company.
Therefore, it is not as if a company with a long operating cycle is a total failure.
operating cycle of a company marketer
If a company is a reseller (trading company), the operating cycle does not include any production time: it is simply the date from the initial cash outlay to the date of receipt of cash from the customer.
Difference between accounting cycle and operating cycle
The main difference between the operating cycle and the accounting cycle is that the operating cycle is a financial reason for activity, while the accounting cycle refers to all that equipo of phases belonging to accounting, which are repeated in each accounting year. .
Phases that go from the registration process of the transactions that economically affect an entity, until the financial information is manifested in the final financial statements.
In such a way that the accounting cycle refers to all the processes that accounting itself carries out each accounting year and the operating cycle is a reason for efficiency.
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