Operating cycle is the number of days a company takes in realizing its inventories in cash. It equals the time taken in selling inventories plus the time taken in recovering cash from trade receivables. It is called operating cycle because this process of producing/purchasing inventories, selling them, recovering cash from customers, using that cash to purchase/produce inventories and so on is repeated as long as the company is in operations.
Operating cycle is a measure of the operating efficiency and working capital management of a company. A short operating cycle is good as it tells that the company's cash is tied up for a shorter period.
Another useful measure used to assess the operating efficiency of a company is the cash cycle (also called the cash conversion cycle).
Operating Cycle = Days' Sales of Inventory + Days Sales Outstanding
Days sales of inventory equals the average number of days in which a company sells its inventory. Days sales outstanding on the other hand, is the period in which receivables are realized in cash.
An alternate expanded formula for operating income is as follows:
|Operating Cycle =||365||× Average Inventories +||365||× Average Accounts Receivable|
Walmart Stores Inc. (NYSE: WMT) is all about inventories. Find its operating cycle assuming all sales are (a) cash sales and (b) credit sales. You can use cost of revenue as approximate figure for purchases (i.e. no need to adjust it for changes in inventories).
|USD in million|
|Cost of revenue||352,488|
|Inventories as at 31 January 2013||43,803|
|Inventories as at 31 January 2012||40,714|
|Accounts receivable as at 31 January 2013||6,768|
|Accounts receivable as at 31 January 2012||5,937|
|Average accounts receivable||6,353|
Days taken in converting inventories to accounts receivable = 365/352,488*42,259 = 43.75
Since there are no credit sales, time taken in recovering cash from accounts receivable is zero. Customers pay cash right away.
Operating cycle is 43.75 days and this represents the time taken in selling inventories.
There is no change in days taken in converting inventories to accounts receivable.
Days taken in converting receivables to cash = 365/469,162*6,353 = 4.92
Operating cycle = days taken in selling + days taken in recovering cash = 43.75 + 4.92 = 48.68
It should be compared with operating cycle of Walmart Competitors, like Amazon, Costco, Target.
Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork