What is the Operating Cycle?

Movie Case Study

The scene shows how Moti (played by Amitabh Bachchan) is extracting sap from palm trees. This sweet drink is later used for brown sugar/jaggery production. Mahjubhi (played by Nutan) pours the hot liquid into moulds to cool it down and makes blocks of jaggery/brown sugar or gud (in Hindi). In this blog, Learning Perspectives explore the meaning of the operating cycle.

What is the Operating Cycle?

The operating cycle is a term used in organizations. It is also called the cash conversion cycle. The operating cycle helps in understanding how much time a company takes to convert raw material into a finished product.

The operating cycle is the time between the acquisition of an asset for processing and its conversion into cash. Similar to the scene we saw, purchasing the raw material, processing it to make a finished product, selling it, and converting it into cash and cash equivalents. The operating cycle is determined for each class of business separately.

For example, if someone has 2-3 businesses dealing with manufacturing, construction, and or trading. Then the operating cycle will be determined for each business separately. Below is how we calculate the operating cycle of a business.

Operating Cycle= 365/Inventory Turnover + 365/Receivables Turnover

Inventory turnover = Cost of goods Sold/ Average turnover

Receivables Turnover = Credit Sales/ Average accounts receivables

Example of Operating Cycle

For example, if a company’s accounts receivable increase at the end of the year, this means that the firm collected less money from its customers.

The scene that you saw shows palm trees, which are the raw material from which sweet sap is being extracted. Then it goes through the step of processing. This sap is being boiled to make sugar syrup from jaggery. The entire process of acquiring the palm trees to the formation of jaggery till earning cash from it. This cycle is referred to as the operating cycle.

Why is the Operating Cycle important?

This cycle determines for the business the speed at which they collect its receivables. This information would help the business to collect its receivables faster.

The operating cycle helps in understanding how fast the company can sell its inventory. If the company isn’t able to sell its products faster, that means the operating cycle will increase.

Understand Operating Cycle with a Video