Operating Cycle

For many businesses, cash is tied up from the moment they buy stock until customers pay for the finished goods. The operating cycle measures that period.

It is calculated by adding days inventory outstanding, the average number of days inventory is held before being sold, and days sales outstanding, the average number of days it takes to collect payment from customers.

For example, if a company holds inventory for an average of 73 days and takes 73 days to collect from customers, its operating cycle is 146 days. Cash spent on stock is not recovered for nearly five months on average.

A shorter operating cycle means cash is tied up for less time, so the business needs less working capital to operate. Businesses can shorten the cycle by holding less inventory, speeding up production and collecting from customers faster.

The operating cycle does not consider how long the business takes to pay its own suppliers. Subtracting days payable outstanding gives the cash conversion cycle, which shows how long the business's own cash is tied up.