Operating Cycle Formula
Okay, so you want to know about the operating cycle formula. It's important to be familiar with it since it can help you make sound business decisions regarding inventory and other operating expenses such as cash flow. Using this, you can help keep your business running smoothly and efficiently.
Formulas and calculations
Operating Cycle = Inventory Period + Accounts Receivable Period
The inventory period is the average time it takes to sell your inventory. To calculate this, divide 365 days (1 year) by your inventory turnover, which can be calculated by dividing your cost of goods sold by your average inventory:
Inventory Period = 365 / (COGS/Average Inventory)
The accounts receivable period is the average time it takes for customers to pay their invoices. To get this, simply divide 365 days by your receivables turnover, which is your sales divided by your average collection period.
Accounts Receivable Period = 365 / (Sales/Accounts Receivable)
Why it's essential
The operating cycle formula, enriched by efficient purchasing software, quantifies the duration required to transform inventory into cash. This metric serves as a tool for evaluating your business's well-being and making essential modifications to ensure smooth operations. For instance, if you discover that the time taken to sell your inventory is excessive, adjustments to pricing or product assortment might be necessary. Conversely, if payment collection lags, it might be prudent to enhance credit policies concerning receivables within your accounting cycle.
In short, the operating cycle is a crucial metric for managing your business. Understanding and monitoring it enables you to make informed decisions that will help keep procurement a seamless process.