What is an Operating Cycle?

An operating cycle is the amount of time a company spends between spending money
operating activities and collecting money from the same operating activity. Operating cycle
often focus on the purchase and sale of assets

Operating cycle is an important concept in management of cash and management of working

capital.

The operating cycle reveals the time that elapses between outlay of cash and inflow of cash.
Quicker the operating cycle less amount of investment in working capital is needed and it
improves the profitability. The duration of the operating cycle depends on the nature of
industry and the efficiency in working capital management.

The above said periods are ascertained as follows:

(a) Raw Material Holding Period:

(b) Work-In-Process Period:

(c) Finished Goods Holding Period:

(d) Receivables Collection Period:

(e) Creditors Payment Period:

The following could be the reasons for longer operating cycle period:
(a) Purchase of materials in excess/short of requirements.

(b) Buying inferior, defective materials.

(c) Failure to get trade discount, cash discount.

(d) Inability to purchase during seasons.

(e) Defective inventory policy.

(f) Use of protracted manufacturing cycle.

(g) Lack of production planning, coordination and control.

(h) Mismatch between production policy and demand.

(i) Use of outdated machinery, technology,

(j) Poor maintenance and upkeep of plant, equipment and infrastructure facilities,

(k) Defective credit policy and slack collection policy.

(l) Inability to get credit from suppliers, employees,

(m) Lack of proper monitoring of external environment etc.

Example
For instance a retailer’s operating cycle would be the time between buying merchandise
inventory and selling the same inventory. A manufacturer’s operating cycle might start when
the company spends money on raw manufacturing materials to make a product. The operating
cycle wouldn’t end until the products are produced and sold to retailers or wholesalers.

Most companies try to keep their operating cycles at a year or less. This means that it would
take a retailer an entire year to sell its inventory. Depending on the industry, this kind of an
inventory turn might be unacceptable. Operating cycles are important because they determine
cash flow. If a company is able to keep a short operating cycle, its cash flow will consistent and
the company won’t have problems paying current liabilities.