What is Operating Cycle Formula?

The cycle plays a significant role in assessing the efficiency of a business. The formula for the operating cycle represents a cash flow calculation that intends to determine the time taken by a company to invest in inventory and other similar resource inputs and then return to the company’s cash account. In other words, the operating cycleThe Operating CycleThe operating cycle of a company, also known as the cash cycle, is an activity ratio that measures the average time required to convert the company’s inventories into cash.read more determines the time a business takes to purchase inventory, then sell the inventory and then collect the cash from the sale of the inventory.

Mathematically, it is represented as,

Operating Cycle Formula = Inventory Period + Accounts Receivable Period

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Operating Cycle Formula (wallstreetmojo.com)

  • The first part is about the current inventory level, and it assesses how quickly the company will be able to sell this inventory. It is represented by the inventory period.Then, the second part is about the credit sales, and it assesses how much time the company can collect the cash from their sales, represented by the account receivable period.

Explanation

Calculation Examples of Operating Cycle

Let’s see some simple to advanced examples to understand them better.

  • Firstly, determine the average inventory during the year, calculated as the average of opening and closing inventory from the balance sheet. Then, the COGS can be computed from the income statement. Now, the inventory period can be calculated by dividing the average inventory by COGS and multiplying by 365 days. Inventory Period = Average Inventory / COGS * 365 Next, determine the average accounts receivable during the year, calculated as the average of opening accounts receivable and closing accounts receivable from the balance sheet. The accounts receivable period can be calculated by dividing average accounts receivable by net credit sales and multiplying by 365 days. Then, the net credit sales can be taken from the income statement. Accounts Receivable Period = Average Accounts Receivable / Net credit sales * 365 Finally, it can be calculated by adding the inventory and accounts receivable periods.

Inventory Period = Average Inventory / COGS * 365

Accounts Receivable Period = Average Accounts Receivable / Net credit sales * 365

Example #1

Let us consider an example to compute the operating cycle for a company named XYZ Ltd. As per the annual reportThe Annual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company’s performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements.read more of XYZ Ltd for the financial year ended on March 31, 20XX, the following information is available.

The following table shows the data for calculation of the operating cycle of company XYZ for the financial year ended on March 31, 20XX.

So, from the above-given data, we will calculate company XYZ’s Inventory Period (days).

= ($3,000 + $5,000) ÷ 2 / $50,000 * 365

= 29.20 days

Now, we will calculate the Account Receivable Period (Days) of company XYZ.

= ($6,000 + $8,000) ÷ 2 / $140,000 * 365

= 18.25 days

Therefore, the calculation of the Operating cycle of company XYZ will be as follows:

Therefore, Operating cycle Formula = Inventory Period + Accounts Receivable Period

= 29.20 days + 18.25 days

OC of company XYZ is as follows:

OC of XYZ Ltd is =47 days.

Example #2

Let us take the example of Apple Inc. to calculate the operating cycle for the financial year ended on September 29, 2018.

The following table shows the data for calculation of the operating cycle of Apple Inc for the financial year ended on September 29, 2018.

So, from the above-given data, we will first calculate the Inventory Period (days) of  Apple Inc.

Therefore, Inventory Period = Average Inventory / Cost of salesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more * 365

= ($4,855 Mn + $3,956 Mn) ÷ 2 / $163,756 Mn * 365

= 9.82 days

Now, we will calculate the Account Receivable Period (Days) of Apple Inc.

= ($17,874 Mn + $23,186 Mn) ÷ 2 / $265,595 Mn * 365

= 28.21 days

Therefore, the calculation is as follows:

Operating cycle Formula = Inventory Period + Accounts Receivable Period

= 9.82 days + 28.21 days

OC of Apple Inc is as follows:

OC of Apple Inc. is =38 days.

Operating Cycle  Calculator

You can use the following Calculator

Relevance and Use

It is essential to understand the concept of the operating cycle formula as it helps to assess how efficiently a company is operating. An analyst can use this cycle to understand a company’s operating efficiency. An analyst would prefer a shorter cycle because it indicates that the business is efficient and successful. Besides, a shorter cycle also indicates that the company will be able to recover its investment fast and has adequate cash to meet its business obligations.

On the other hand, if a company has the longest cycle, it means that it takes a long time to convert its inventory purchases into cash. Such a company can improve its cycle either by implementing measures to quickly sell off its inventory or reduce the time needed to collect receivables.

The operating cycle formula can compare companies in the same industry or conduct trend analysisTrend AnalysisTrend analysis is an analysis of the company’s trend by comparing its financial statements to analyze the market trend or analysis of the future based on past performance results, and it is an attempt to make the best decisions based on the results of the analysis done.read more to assess their performance across the years. A comparison of a company’s cash cycle to its competitors can be helpful to determine if the company is operating normally vis-à-vis other players in the industry. Also, comparing a company’s current operating cycle to its previous year can help conclude whether its operations are on the path of improvement or not.

Guide to Operating Cycle Formula. Here we discuss how to calculate the Operating Cycle using practical examples and downloadable excel templates. You may learn more about Financial Analysis from the following articles –

  • Calculate Cash Conversion CycleWhat is the Accounting Cycle?What Is The Accounting Cycle?Accounting Cycle refers to the process of recording transactions and summarizing them for the preparation of financial statements. The objective is to generate useful information in the form of three financial statements namely Income Statement, Balance Sheet and Cash Flows. read moreWorking Capital Ratio Formula