What Is an Operating Cycle?

What Is an Operating Cycle?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

An operating cycle, in simple terms, is the average period of time required for a business to make an initial outlay of cash to produce goods, sell the goods, and receive cash from customers in exchange for these goods. The length of an operating cycle can vary from business to business but usually encompasses the following steps: buying resources, producing the product, selling the product, and finally collecting payment for the product.

Related Questions

1. What factors can influence the length of an operating cycle?

The length of an operating cycle can differ greatly between businesses due to various factors. These factors include the type of business, the industry it belongs to, inventory turnover rate, collection period for accounts receivable, and payment terms for accounts payable.

2. What happens if a company has a longer operating cycle?

Want More Financial Tips?

Get Our Best Stuff First (for FREE)
We respect your privacy and you can unsubscribe anytime.

If a company has a relatively long operating cycle, it means that the company takes more time to convert its inventory and other inputs into cash. This could potentially lead to cash flow issues, especially for small businesses or start-ups that may not have large cash reserves to sustain their operations during this extended period.

3. How can a company shorten its operating cycle?

A company can shorten its operating cycle by improving its inventory turnover rate and collection period. This might involve negotiating quicker payment terms with customers, speeding up the production process or better managing inventory to reduce the time it sits in a warehouse.

4. What is the difference between an operating cycle and a cash cycle?

The operating cycle focuses on the time it takes from purchasing inventory to collecting cash after selling it. The cash cycle, on the other hand, starts when the business pays cash to suppliers and ends when the business receives cash from customers. So, the cash cycle considers the time the business takes to pay its suppliers too.

5. What is the significance of analyzing the operating cycle?

Understanding a company’s operating cycle is crucial to grasp its business model and the liquidity of its working capital. A well-managed operating cycle that aligns with the business’s cash flow will contribute positively to the company’s growth and sustainability.