The term of operating cycle (otherwise you can call it the cash cycle ) was defined as the time between the sale of manufactured goods and the receipt of payment for it. For an enterprise, the operating cycle begins with the moment when company buying stocktaking and supply goods and finish when the customer transfer money for purchased cargo. The operating cycle is a necessary transaction if the company wants to sell goods to customers and charge payment for this . The duration of the operating cycle depends on the type of business. However, it usually lasts a calendar year, i.e. it starts on the first of January and ends on December 31. Various branches of industry could have different cycle length like for an exapmle this cycle in fashion industry cannot be too long and usually takes maximum 6 months but on the other hand in the maschine industry or ship manufacturing it could be two or three years. Each branch of industry has its own unique factors that influence the duration of the operating cycle .
Stages of Operating cycle
The operating cycle includes:
- First of all the company is processing on raw material inventory,
- Second stage is packing and storage in warehause
- The next one includes finished goods,
- In fourth point companies sold that goods on credit,
- Next stage includes accounts receivable,
- After that the company receive payment for clients,
- The next step in operating is getting cash from the customer,
- The last one stages is about buying again raw material and repeat this cycle from scratch.
Use of the Operating cycle
Thanks to this cycle, each company has the ability to control the companies earnings and expenses. By observing the operating cycle, the company can analyze the cost structure and take preventive measures when something goes wrong in individual cycles . Observation of subsequent cycles gives the opportunity to improve the next ones. Thanks to this, we companies also avoid mistakes that occurred in previous cycles and improve the entire process. The operating cycle is also useful when one of the companies want to compare its revenues and costs with the situation in another company with a similar business profile . As the duration of operating cycles can differ many companies adjust their cycle to the calendar year which gives them a clear view of the net profit they earned in a given year. However, for some enterprises it would be more adequate to adjust their cycle to the seasonable earnings as for an example a ski resort would be more interesed in how much income they made during winter season which includes the turn of two years. A business operating in similar way, would start its cycle from first day of July and ending with the last day of June next year .
Examples of Operating cycle
- Manufacturing companies: The operating cycle of a manufacturing company typically starts with the acquisition of raw materials and components. This is followed by the production process, which includes the assembly of the goods, testing and quality assurance, and packaging and shipping. The goods are then sold to customers, who may pay upon receipt or pay in installments. The process ends with the collection of payments from customers, which then allows the company to purchase more raw materials and components for the next cycle.
- Retailers: The operating cycle of a retailer begins with the purchase of inventory from suppliers. The inventory is then stocked in the store, usually with some sort of display so that customers can easily find what they are looking for. Customers then come into the store and purchase the items, either with cash or with a credit card. The retailer then processes the payment and the cycle ends with the collection of the payments from customers.
- Service providers: The operating cycle of a service provider is typically much shorter than the cycle of a retailer or manufacturer. It begins with the acquisition of customers, either through advertising or referrals. The service provider then provides the service to the customer, which may include consultation, installation, and maintenance. The process ends with the collection of payments from customers, which then allows the service provider to acquire more customers.
Advantages of Operating cycle
The Operating Cycle is a process consisting of a series of steps which are necessary to complete a business transaction. It is important to understand the Operating Cycle as it is a crucial element of a business’s financial management. Below are some of the advantages of Operating Cycle:
- It allows companies to measure their financial performance and identify areas of improvement.
- It enables companies to keep track of the resources they need and how they are used.
- It helps companies to accurately forecast their cash flow, ensuring they have enough money to cover their operations.
- It enables companies to plan for future investments and expenses.
- It helps companies to manage their inventory and ensure they have the right stock at the right time.
- It helps companies to identify areas where cost-cutting can be implemented.
- It helps companies to identify areas of revenue growth.
- It helps companies to ensure their financial statements are accurate and up-to-date.
Limitations of Operating cycle
The Operating cycle is an important concept in accounting and business management. Although it has many benefits, there are certain limitations associated with it. These include:
- A lack of precision in terms of the exact timing of cash flows. The operating cycle is typically measured in terms of days, but the actual timing of cash flows may not be as precise as anticipated.
- It does not consider the impact of external factors that can influence the operating cycle. For example, changes in economic conditions, customer payment patterns, or supplier delivery times can all have an impact on the operating cycle.
- It does not take into account the full value of assets and liabilities. Operating cycle only considers the current assets and current liabilities associated with a business, not the total value of its assets and liabilities.
- It does not consider the impact of hedging activities. Hedging activities, such as currency hedging or risk management, are not typically included in the operating cycle.
- It does not factor in any changes in accounting methods. The operating cycle is typically based on a given accounting method, such as accrual or cash-basis accounting, and does not take into account any subsequent changes in accounting methods.
The Operating Cycle is a process of transforming resources into products or services and selling them to customers. Other approaches related to the Operating Cycle include:
- Cash Conversion Cycle (CCC): It is a measure of the time it takes for a company to convert its investments in inventory and other resources into cash from sales.
- Profit Cycle: It is the process of generating profits from the sale of products or services.
- Inventory Management Cycle: It is the process of managing inventory levels in order to ensure that the company has the right amount of inventory at the right time in order to meet customer demand.
- Production Cycle: It is the process of producing products from raw materials and components.
- Procurement Cycle: It is the process of acquiring goods and services from suppliers.
In summary, the Operating Cycle is the process of transforming resources into products or services and selling them to customers. Other approaches related to the Operating Cycle include the Cash Conversion Cycle, Profit Cycle, Inventory Management Cycle, Production Cycle, and Procurement Cycle.
- Khan M.Y, Jain P.K (2017) Financial Management, McGraw Hill Education, p.13-9
- Porter G.A, Norton C.L (2012) Financial Accounting: the Impact on Decision Makers, South-Western, p. 61
- Koester E. (2009) What every Engineer Should Know about starting a high-tech business Venture, CRC Press, p. 473
- Berry A. (1999) Financial Accounting: An Introduction, Cengage Leearning EMEA, p. 69
- Camillus J. (1998) Strategic Planning and Management Control: Systems for Survival and Success, Lexington Books, p.168
- Ramachadran N, Kakanu R.K (2005) Fiancial Accounting of Management, Tata McGraw-Hill Education, p. 46
- Awasthi D, Jaggi R, Padmanand V (2006) A Manual for Entrepreneurs: Food Processing Industry, Tata McGraw-Hill, New Delhi, p.175
- Gibson CH.H (2012) Financial Reporting and Analysis: Using Financial Accounting Inforamtion, South-Western Cengage Learning, p. 219
- Koester E. (2009) What every Engineer Should Know about starting a high-tech business Venture, CRC Press. p.473
|Operating cycle — recommended articles|
|Inventory accounting — Inventory value — Finished goods inventory — Merchandise inventory — Opening stock — Master budget — Net purchases — Segment margin — Purchase returns and allowances|
- Awasthi D, Jaggi R, Padmanand V (2006) Manual for Entrepreneurs: Food Processing Industry, Tata McGraw-Hill, New Delhi
- Berry A. (1999) Financial Accounting: An Introduction, Cengage Leearning EMEA
- Camillus J. (1998) Strategic Planning and Management Control: Systems for Survival and Success, Lexington Books
- Gibson CH.H (2012) Financial Reporting and Analysis: Using Financial Accounting Inforamtion, South-Western Cengage Learning
- Khan M.Y, Jain P.K (2017) Financial management|Financial Management, McGraw Hill Education
- Koester E. (2009) What every Engineer Should Know about starting a high-tech business Venture, CRC Press,
- Porter G.A, Norton C.L (2012) Financial Accounting: the Impact on Decision Makers, South-Western
- Ramachadran N, Kakanu R.K (2005) Fiancial Accounting of Management, Tata McGraw-Hill Education
Author: Aleksandra Wróbel