## What is Operating Cycle Formula?

The formula for operating cycle basically represents a cash flow calculation that intends to determine the time taken by a company to invest in inventory and other similar resource inputs and then return to the company’s cash account. In other words, the operating cycle determines the time taken by a business to purchase inventory, then sell the inventory and then collect the cash from the sale of the inventory. The cycle plays a significant role in assessing the efficiency of a business.

Mathematically, it is represented as,

**Operating Cycle Formula = Inventory Period + Accounts Receivable Period**

- The first part is pertaining to the current inventory level and it assesses how quickly the company will be able to sell this inventory and it is represented by the inventory period.
- Then, the second part is pertaining to the credit sales and it asses in how much of amount of time the company is able to collect the cash from their sales and it is represented by account receivable period.

### Explanation

The formula is very simple as all the required information is easily available in the balance sheet and the income statement and it can be derived by using the following three steps:

**Step 1:** Firstly, determine the average inventory during the year which can be calculated as the average of opening inventory and closing inventory from the balance sheet. Then, the Cost of goods sold (COGS) can be computed from the income statement. Now, the inventory period can be calculated by dividing the average inventory by COGS and multiplied by 365 days.

**Inventory Period = Average Inventory / COGS * 365**

**Step 2:** Next, determine the average accounts receivable during the year which can be calculated as the average of opening accounts receivable and closing accounts receivable from the balance sheet. Then, the net credit sales can be taken from the income statement. Now, the accounts receivable period can be calculated by dividing average accounts receivable by net credit sales and multiplied by 365 days.

**Accounts Receivable Period = Average Accounts Receivable / Net credit sales * 365**

**Step 3:** Finally, it can be calculated by adding the inventory period and accounts receivable period

### Calculation Examples of Operating Cycle

Let’s see some simple to advanced examples to understand it better.

#### Example #1

**Let us consider an example to compute the operating cycle for a company named XYZ Ltd.**** As per the annual report of XYZ Ltd for the financial year ended on March 31, 20XX, the following information is available.**

The following table shows the data for calculation of the operating cycle of company XYZ for the financial year ended on March 31, 20XX.

So, from above-given data we will calculate Inventory Period (days) of company XYZ

Inventory Period = Average Inventory / COGS * 365

= ($3,000 + $5,000) ÷ 2 / $50,000 * 365

=** 29.20 days**

Now , we will calculate Account Receivable Period (Days) of company XYZ.

Accounts Receivable Period = Average Accounts Receivable / Net credit sales * 365

= ($6,000 + $8,000) ÷ 2 / $140,000 * 365

**= 18.25 days**

Therefore, the calculation of Operating cycle of company XYZ will be as follows:

Therefore, Operating cycle Formula = Inventory Period + Accounts Receivable Period

= 29.20 days + 18.25 days

OC of company XYZ is as follows:

OC of XYZ Ltd is =**47 days.**

#### Example #2

**Let us take the example of Apple Inc. to calculate the operating cycle for the financial year ended on September 29, 2018. **

The following table shows the data for calculation of the operating cycle of Apple Inc for the financial year ended on September 29, 2018.

So, from above-given data, we will first calculate Inventory Period (days) of Apple Inc.

Therefore,Inventory Period = Average Inventory / Cost of sales * 365

= ($4,855 Mn + $3,956 Mn) ÷ 2 / $163,756 Mn * 365

**= 9.82 days**

Now , we will calculate Account Receivable Period (Days) of Apple Inc.

Accounts Receivable Period = Average Accounts Receivable / Net credit sales * 365

= ($17,874 Mn + $23,186 Mn) ÷ 2 / $265,595 Mn * 365

= **28.21 days**

Therefore, the calculation is as follows:

Operating cycle Formula = Inventory Period + Accounts Receivable Period

= 9.82 days + 28.21 days

OC of Apple Inc is as follows:

OC of Apple Inc. is =**38 days.**

### Operating Cycle Calculator

You can use the following Calculator

Inventory Period | |

Accounts Receivable Period | |

Operating Cycle Formula = | |

Operating Cycle Formula = | Inventory Period + Accounts Receivable Period | |

0 + 0 = | 0 |

### Relevance and Use

It is important to understand the concept of the operating cycle formula as it helps to assess how efficiently a company is operating. An analyst can use this cycle to have an understanding of a company’s operating efficiency. An analyst would prefer a shorter cycle because it indicates that the business is efficient and successful. Besides, a shorter cycle also indicates that the company will be able to recover its investment fast and has adequate cash to meet its business obligations.

On the other hand, if a company has the longest cycle, then it means that the company takes a longer time to convert its inventory purchases into cash. Such a company can improve its cycle either by implementing measures to quickly sell off its inventory or reduce the time needed to collect receivables.

The operating cycle formula can be used to compare companies in the same industry or conduct a trend analysis to assess its own performance across the years. Comparison of a company’s cash cycle to its competitors can be helpful to determine if the company is operating normally vis-à-vis other players in the industry. In addition, comparing a company’s current operating cycle to its previous year can be helpful in drawing the conclusion that whether its operations are on the path of improvement or not.

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