Loans
Cards
Insurance
Investment
Stock Market
Electronics Mall
CIBIL Score
Knowledge Centre
Calculators
Do not call
En
Understand the operating cycle and how it tracks the time taken to convert inventory into cash.
The Operating Cycle (OC) is a key financial metric that measures the total time a business takes to convert its investment in inventory into cash. It tracks how efficiently a company purchases goods, sells them, and collects payments from customers. A shorter operating cycle indicates improved liquidity, stronger cash flow, and efficient operations.
The Operating Cycle represents the number of days a company needs to turn raw materials or inventory into cash.
It includes all major working-capital stages:
Buying inventory
Selling goods/services
Collecting receivables
A shorter cycle reflects faster movement from inventory to cash.
A longer cycle reflects slower cash movement and potentially higher working-capital requirements.
In simple terms, the operating cycle tells you: How long does it take for a company to get its cash back after investing in inventory.
It begins when inventory is purchased and ends when the company receives payment from customers.
From a financial management perspective, the operating cycle:
Reflects operational efficiency
Helps estimate working-capital requirements
Influences liquidity decisions
Affects financing and cash-flow planning
Impacts profitability and credit policies
It is an important component in managing short-term capital effectively.
The general formula is:
Where:
Inventory Conversion Period (ICP) = Time to convert inventory to sales
Receivables Conversion Period (RCP) = Time taken to collect money from customers
Follow these steps:
Calculate DIO (Days Inventory Outstanding):
DIO = (Average Inventory ÷ Cost of Goods Sold) × 365
Calculate DSO (Days Sales Outstanding):
DSO = (Average Accounts Receivable ÷ Net Credit Sales) × 365
Add DIO + DSO to get the Operating Cycle.
Annual averages may provide a more stable view, but ensuring accuracy requires consistent data.
The operating cycle method evaluates the liquidity of a business by analysing how long capital stays tied up in inventory and receivables. It focuses on:
Purchase stage
Production/storage stage
Sales stage
Collection stage
This helps determine how much working capital a company needs to support operations.
Suppose a company reports:
Average Inventory: ₹5,00,000
COGS: ₹20,00,000
Average Accounts Receivable: ₹3,00,000
Net Credit Sales: ₹24,00,000
DIO = (5,00,000 ÷ 20,00,000) × 365 = 91.25 days
DSO = (3,00,000 ÷ 24,00,000) × 365 = 45.62 days
Operating Cycle = 91.25 + 45.62 = 136.87 days
Meaning:
The business takes around 137 days to convert inventory investments back into cash.
Consider the following table:
| Component | Meaning |
|---|---|
Inventory Period (DIO) |
Time taken to convert inventory to sales |
Receivables Period (DSO) |
Time taken to collect money from customers |
Sales Stage |
Finished goods sold to customers |
Cash Collection |
Receipts collected from credit sales |
The operating cycle is important because it:
Shows efficiency of inventory and receivables management
Helps plan working-capital needs
Impacts cash-flow forecasting
Influences credit and sales policies
Guides decisions on pricing, purchasing, and inventory levels
Helps compare operational efficiency across businesses
Key factors include:
Nature of industry (retail vs manufacturing)
Inventory turnover rate
Production cycle time
Credit terms offered to customers
Supplier credit terms
Demand seasonality
Efficiency of receivables collection
Product type (perishable vs durable)
Consider the difference between both cycles:
| Feature | Operating Cycle | Cash Conversion Cycle |
|---|---|---|
Definition |
Time from inventory purchase to cash collection |
Time from cash paid to suppliers to cash received from customers |
Includes Payables? |
No |
Yes (subtracts payables period) |
Focus |
Efficiency of inventory + receivables |
Full cash movement cycle |
Formula |
DIO + DSO |
DIO + DSO – DPO |
Several operational and structural elements may influence the duration of the operating cycle, such as:
Inventory movement patterns, including the speed at which goods progress through storage or production stages.
Production timelines, depending on the nature of manufacturing or processing. activities
Credit terms extended to customers, which affect the timing of receivables collection.
Customer payment behavior, including the consistency and timeliness of collections.
Invoicing and processing cycles, which can impact how quickly receivables are recorded and followed up.
Supplier payment terms, which may affect the overall cash-flow sequence when considered alongside receivables.
Demand fluctuations, particularly in seasonal or cyclical industries.
Product characteristics, such as whether items are perishable, customised, or have longer production or sales cycles.
Does not consider payables (unlike CCC)
Seasonal industries may show distorted cycles
Requires accurate inventory and receivables data
Not fully comparable across industries
Does not reflect cash discounts or returns
The Operating Cycle offers a clear view of how efficiently a company manages its working capital and converts resources into cash flow. It reflects both operational speed and liquidity strength.
Key points to note:
The Operating Cycle measures how long it takes to convert inventory into cash.
A shorter cycle means improved liquidity and efficient operations.
It includes inventory days and receivables days.
Useful for working-capital planning and evaluating operational performance.
Should be compared with industry benchmarks for accurate insights.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The Operating Cycle is calculated using the formula:
Operating Cycle = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO).
It represents the time taken to convert inventory into cash through sales and collections.
To calculate the Operating Cycle, determine DIO and DSO using financial data such as inventory levels, cost of goods sold, receivables, and credit sales. Once these two components are computed, add them together to arrive at the number of days in the Operating Cycle.
The Operating Cycle is important because it helps estimate working-capital needs and measure how efficiently a business manages its inventory and receivables. A shorter cycle generally indicates stronger liquidity and operational efficiency.
The Operating Cycle measures the time taken to convert inventory into cash, while the Cash Conversion Cycle refines this measure by subtracting the payables period. The CCC therefore reflects net cash tied up in operations after accounting for supplier credit.
Key factors influencing the Operating Cycle include inventory turnover speed, production timelines, sales cycle efficiency, credit policy terms, customer payment behaviour, and supplier payment conditions. Changes in any of these elements can lengthen or shorten the cycle.
.jpeg)
77251
Unlock the world of credit! From picking the perfect card to savvy loan management, navigate wisely.
44481
Money Management and Financial Planning covers personal finance basics, setting goals, budgeting...
21017
Explore the investment cosmos! From beginner's guides to sharp-witted strategies, explore India's treasure trove of options.
34777
Navigate the tax maze with ease! Uncover Income Tax 101, demystify jargon with Terms for Beginners, and choose between Old or New Regimes.
8435
Discover essential insights on various types of insurance in India.
4408
Welcome to Tech in Finance, where we explore the exciting intersection of technology and finance...
Personal Loan, Business Loan, Collateral
Credit Score, Report & Analysis
Fixed Deposit, Mutual Fund, NPS, Demat A/C, SGB
General Insurance, Life Insurance, Term Insurance
Stocks, IPOs
Smart Phone, Speaker, EarPhone
Academy 
.jpeg "image not found")
