The Operating Cycle

Any manufacturing activity is characterized by a cycle of operations consisting of buy of raw fabrics for cash or credit, converting these into finished goods and realizing cash by sale of these finished goods. The manufacturing activity in fact consists of a sequence of such operating cycles. The time gap between cash outlay and cash realization by sale of finished goods and realization of sundry debtors is called as the length regarding the operating cycle. The operating cycle consists of:. Time taken to procure the raw fabrics and the average period for which the raw fabrics are in store.

Time compulsory for the process of conversion. Average period for which the finished goods are in store. Average collection period of receivables sundry debtors. The operating cycle shall also be called as cash to cash cycle and it indicates as to how cash is converted into raw materials, stock-in-process, finished goods, bills receivables and finally return to cash. Working capital is the total cash that is meant for circulation in this cycle.

As such, the working capital shall be turned over or redeployed subsequent to completing the cycle. The following are the events on the cash flow line:. The firm begins with the buy of raw materials, which are paid by delayed remittances called as Accounts payable period. The firm converts the raw fabrics into finished goods and the finished goods are sold. The time lag between the buy of raw fabrics and the sale of finished goods is called as the inventory period.

When the finished goods are sold, cash is not received for the entire goods sold. Payments for some component regarding the goods are received subsequent to some period. The time gap between the date of sale of goods and the date of collection of receivables is called as accounts receivable period. The time gap between the buy of raw fabrics and the collection of cash for the entire sales is referred to as operating cycle. The time gap between the payment for raw fabrics purchases and the collection of cash for sales is referred to as cash cycle.

The operating cycle is the sum total regarding the inventory period and the accounts receivable period, whereas the cash cycle is equal to operating cycle fewer the accounts payable period. Reduction within the length regarding the operating cycle shall be achieved only by better management of one or more regarding the lone phases regarding the operating cycle. This, in turn, should lead to improvement in productivity and better management in a large many different variations of operational activities ranging from inventory manage and production planning to marketing and credit management. Salient features regarding the operating cycle:. The length regarding the operating cycle differs from sector to sector and from one firm to another firm within the similar to industry.

The concept enables us to assess the working capital wants of each enterprise keeping in mind the peculiarities regarding the sector to which it is engaged and it's scale of operations. It is an important management tool in decision making. While analyzing the working capital requirements of any firm, the credit analyst has to hold in mind the abovementioned factors.