Operating cycle definition
The operating cycle is the time required for a company’s cash to be put into its operations and then return to the company’s cash account.
Operating cycle example
A manufacturer’s operating cycle is amount of time required for the manufacturer’s cash to be used to:
- pay for the raw materials needed in its products
- pay for the labor and overhead costs needed to convert the raw materials into products
- hold the finished products in inventory until they are sold
- wait for the customers’ cash payments to be collected
The operating cycle is the sum of the following:
- the days’ sales in inventory (365 days/inventory turnover ratio), plus
- the average collection period (365 days/accounts receivable turnover ratio)
The operating cycle has importance in classifying current assets and current liabilities. While most manufacturers have operating cycles of several months, a few industries require very long processing times. This could result in an operating cycle that is longer than one year. To accommodate those industries, the accountants’ definitions of current assets and current liabilities include the following phrase: …within one year or within the operating cycle, whichever is longer.
To assist you in computing and understanding accounting ratios, we developed 24 forms that are available as part of AccountingCoach PRO.
You can also read our Explanation of Financial Ratios.
