5/8/2011

How do you calculate the Operating Cyc

How do you calculate the Operating Cycle ratio of a business?

Calculating the Operating Cycle ratio of a business - Master level
The Operating Cycle ratio of a business is calculated by adding the average number of days where cash is tied up in inventory and accounts receivable and then subtracting the average number of days where bills have not yet been paid.

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Operating cycle ratio of a business

Formula for the Operating Cycle ratio of a business

The Operating Cycle of a business is also known as the "Cash Operating Cycle", the "Cash to Cash Cycle", the "Cash Conversion Cycle" or simply the "Cash Cycle". The Operating Cycle ratio is a metric that measures the average duration of time (in days) it takes for a business to turn purchased inventory into cash receipts from its eventual sale. The Operating Cycle ratio is calculated using the following components: Operating Cycle ratio = Inventory days + Receivable days - Unpaid bill days where: Inventory days = Average number of days that cash is locked-up in inventory Receivable days = Average number of days that cash is locked-up in accounts receivables Unpaid bill days = Average number of days where extra cash is available because the business has not yet paid its bills. Note: Credit provided by suppliers becomes additional working capital for the business and so reduces the Operating Cycle ratio.

Calculating the Operating Cycle ratio of a business

To calculate the Operating Cycle ratio of a business you will need access to information contained in the financial statements. i.e. the Balance Sheet and the Income Statement. For example: Extract from the financial statements - Balance Sheet Account Accounts Receivable
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1 June 4,000

30 June 6,000
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5/8/2011

How do you calculate the Operating Cyc

Inventory (Raw materials, Work-In-Progress & Finished Goods) Accounts Payable Extract from the financial statements - Income Statement Account Sales Cost of Goods Sold Gross Profit margin

5,000 3,000

3,000 1,000

30 June 10,000 7,000 3,000

To calculate each of the components of the Operating Cycle ratio in the given reporting period (i.e. June with 30 days): Inventory days = Average $ value of inventory / (Cost or Goods Sold / Reporting period days) i.e. ((5,000 + 3,000)/2) / (7,000 / 30) = 4,000 / 233.33 = 17.14 days. This is how many days worth of stock that is held by the business during the period. Receivable days = Average $ value of Accounts receivable / (Sales / Reporting period days) i.e. ((4,000 + 6,000)/2) / (10,000 / 30 days) = 5,000 / 333.33 = 15.00 days. This is the average length of time it takes for customers (debtors) to pay their accounts. Unpaid bill days = Average $ value of Accounts Payable / (Cost or Goods Sold / Reporting period days) = ((3,000 + 1,000)/2) / (7,000 / 30) = 2,000 / 233.33 = 8.57 days. This is the average length of time that the business takes to pay it's bills. So, the Operating Cycle ratio for the example above = 17.14 days + 15.00 days - 8.57 days = 23.57 days. This ratio represents the average number of days that cash is locked up in the non-cash working capital of the business and is unavailable for other investment options. By comparing this metric against previous periods, industry benchmarks or key competitors, you will be able to assess the effectiveness of the working capital management of the business.

Operating Cycle ratio

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