Operating Cycle Calculator

Operating Cycle

The operating cycle calculator calculates the period for the working capital requirement during which cash is converted back into cash. This process of converting cash to cash can be explained with the help of the following diagram.

operating cycle

Raw materials are purchased either on cash or credit and processed through two stages, that is, work-in-progress and finally finished goods. These finished goods are again sold either on cash or credit and the cash realized from the accounts receivable is then used to pay off the accounts payable from which goods were purchased on credit. This process of conversion of raw materials into cash is operating cycle.

Formula For Calculating Operating Cycle

In order to calculate operating cycle, consider the following formula:

Operating Cycle = Inventory Holding Period + Accounts Receivable Period

where, Inventory Holding Period = 365 / Inventory Turnover

and Inventory Turnover = COGS / Average Inventory

Accounts Receivable Period = 365 / Receivable Turnover

and Receivable Turnover = Credit Sales / Average Accounts Receivable

About the Calculator / Features

The Operating Cycle Calculator provides a quick result in one simple click to the user after he has inputted the following details to the calculator.

  • Cost of goods sold (COGS)
  • Average inventory
  • Credit sales
  • Average account receivable

Calculator

How to Calculate using Calculator

The user have to insert the following data into the calculator for an instant result of operating cycle.

Cost of Goods Sold (COGS)

For calculating COGS, one have to consider a simple formula.

COGS = Opening inventory + Purchases made during the period – Closing inventory

Average Inventory

It is the average of opening and closing inventory.

Average Inventory = (Opening inventory + closing inventory) / 2

Credit Sales

It is the portion of total sales that is sold for credit to accounts receivables.

Average Accounts Receivables

It is the average of opening and closing account receivables.

Average Accounts Receivables = (opening receivables + closing receivables) / 2

Example of Operating Cycle

Let us try to understand the concept of operating cycle with the help of an example.

Calculate the Operating Cycle of XYZ ltd. from the following data:

  • Opening inventory = $115,000
  • Closing inventory = $175,000
  • Opening receivables = $87,500
  • Closing receivables = $115,000
  • COGS = $425,000
  • Credit sales = 650,000
ParticularsOpening Balance ($)Closing balance ($)Average ($)
Inventory115,000175,000145,000
Receivables87,500115,000101,250

Inventory Turnover = 425,000 / 145,000 = 2.93

Inventory Holding Period = 365 / 2.93 = 124.57 days

Receivable Turnover = 650,000 / 101,250 = 6.42

Accounts Receivable period = 365 / 6.42 = 56.85 days

Therefore, Operating Cycle = 124.57 + 56.85 = 181.42 days

Interpretation of Operating Cycle

In the example above, the operating cycle period is 181.42 days, that is, approx. 182 days. This means that it will take 182 days to convert cash into cash again. For efficient functioning of an organization, it is important that there is a smooth flow of operating cash flow to sustain this cycle. Else, there will be bottolenecks at production levels due to cash flow cruch. And the company will not be able to operate efficiently and at the desired capacity. Moreover, the shortage of funds may also raise the cost of purchases, either stretching credit period so suppliers will increase the cost, or increase in frequency of purchases leading to increaed cost of raw material procurement.

Therefore, it is very essential that enough working capital is available to maintain the operating cycle. In absence of which the company may loose the market, reputation, credentials, besides higher operating cost.

Cautions

A manager should always try to minimize the operating cycle period. There are various method by which inventory holding period can be reduced and the most popular of all is JIT (Just In Time). Similarly, receivable period can also be reduced by framing proper credit policies.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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