In: Finance
Describe the characteristics of the operating cycle and the cash cycle. (150 words, in your own words)
Operating cycle
An operating cycle represents the amount of time it takes a company
to acquire inventory, sell that inventory, and receive cash from
its customers in exchange for the inventory sold. The length of a
company's operating cycle is dictated by a number of factors,
including the payment terms a company extends to its customers and
those extended to the company by its suppliers. If a company is
given more time to pay its suppliers for inventory, it can reduce
its operating cycle by delaying the outlay of cash. On the other
hand, if a company gives its customers more time to pay for goods
received, it can extend its operating cycle, as the company will
have to wait longer to get its cash. A shorter operating cycle
indicates that a company's cash is tied up for a shorter period of
time, which is generally more ideal from a cash flow
perspective.
Cash cycle
Also known as a cash conversion cycle, a cash cycle represents the
amount of time it takes a company to convert resources to cash. The
cash cycle calculates the time during which each dollar is
committed to various production and sales processes before it is
then converted to cash in the form of accounts receivable, or paid
invoices. The cash cycle begins when a company pays to purchase
inventory and ends when that money is recovered by receiving
payment from customers. When a company's cash is committed to
production and sales processes, it is, by default, unavailable for
other purposes, including investment and growth. A shorter cash
cycle, therefore, indicates that a company has more reliable access
to cash on hand, and more opportunities to use that cash to further
the business.
Interaction of operating and cash
cycle
While both cycles serve similar purposes, the operating cycle
offers insight into a company's operating efficiencies, while the
cash cycle offers insight as to how well a company is managing its
cash flow. Additionally, it's often the case that one cycle impacts
the other in practice. A shorter operating cycle can lead to a
shorter cash cycle, while a longer operating cycle can result in a
more lengthy cash cycle. It's therefore important for companies to
analyze these cycles individually as well as jointly.
Please comment for amy query and dont forget to give a thumbs up