Category: 

What Is an Operating Cycle?

Perishable goods require a short operating cycle.
The operation cycle refers to the period of time it takes to acquire, then sell inventory and profit.
Some businesses, such as distilleries that require an aged product, have a longer operating cycle.
Article Details
  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 07 July 2014
  • Copyright Protected:
    2003-2014
    Conjecture Corporation
  • Print this Article
Free Widgets for your Site/Blog
The average age of a NASA engineer at the time of the Apollo missions was 28, now the average age is 47.  more...

July 29 ,  1976 :  The "Son of Sam" killed for the first time, beginning a long reign of terror on New   more...

An operating cycle is the length of time between the acquisition of inventory and the sale of that inventory and subsequent generation of a profit. The shorter it is, the faster a business gets a return on investment (ROI) for the inventory it stocks. As a general rule, companies want to keep their operating cycles short for a number of reasons, but in certain industries, a long one is actually the norm. These cycles are not tied to accounting periods, but are rather calculated in terms of how long goods sit in inventory before sale.

When a business buys inventory, it ties up money in the inventory until it can be sold. This money may be borrowed or paid up front, but in either case, once the business has purchased inventory, those funds are not available for other uses. The business views this as an acceptable tradeoff because the inventory is an investment that will hopefully generate returns, but keeping the operating cycle short is still a goal for most businesses so they can keep their liquidity high.

Ad

Keeping inventory during a long operating cycle does not just tie up funds. Items must be stored and this can become costly, especially with inventory that requires special handling, such as humidity controls or security. Furthermore, inventory can depreciate if it is kept in a store too long. In the case of perishable goods, it can even be rendered unsaleable. Inventory must also be insured and managed by staff members who need to be paid, and this adds to overall operating expenses.

There are cases where keeping a lot of inventory for a long time in unavoidable. Wineries and distilleries, for example, keep inventory on hand for years before it is sold, because of the nature of the business. In these industries, the return on investment happens in the long term, rather than the short term, and such companies are usually structured in a way that allows them to borrow against existing inventory or land if funds are needed to finance short-term operations.

Operating cycles can fluctuate. During periods of economic stagnation, inventory tends to sit around longer, while periods of growth may be marked by more rapid turnover. Certain products can be consistent sellers that move in and out of inventory quickly, while others, like big ticket items, may be purchased less frequently. All of these issues must be accounted for when making decisions about ordering and pricing items for inventory.

Ad

Discuss this Article

miriam98
Post 4

@hamje32 - I don’t think that you have to offshore anything.

I believe that you just need to get an Enterprise Resource Planning software system. That’s what these software packages are designed to do. They look at hold times for inventory, and using historical trends and looking at customer demand they make projections of how much inventory the business needs on hand at any one given time.

These software programs have a proven track record and should be part and parcel of any manufacturing operating in my opinion. I’ve use these programs in the past and they work like a charm.

hamje32
Post 3

@Charred - I think the optimal business is one where you can turn around inventory quickly.

I realize that we're limited in this discussion to manufacturing; if you’re in the service industry, you can pretty much limit or avoid this dilemma altogether.

But one way that people who make stuff can limit their net working capital is to offshore some of the manufacturing to other companies, assuming that it’s cheaper to do so.

These companies may have better turnaround times on products and the business can avoid the costs of holding inventory in house until sales become payable.

Charred
Post 2

@NathanG - That’s true, but that sword cuts both ways.

Businesses have to buy materials for their inventory. If they can negotiate longer payment terms with the supplier, they can improve their cash operating cycle.

It’s quite possible that by the time the businesses actually make the cash payments on their invoices, the sales will have come in on their products, and so that would be a win-win scenario in my opinion.

NathanG
Post 1

One of the things that I think has always hurt some businesses is the generous payment terms they offer on some of their invoices.

They’ll offer 30 days, 60 days or even 90 days for the buyer to make the payment. I think that this is great for the buyer, because human nature being what it is, they’ll take all the time that is allowed to them.

I believe that 30 days is fair, but why anyone should be extended payment terms of 90 days is beyond me. A longer payment cycle means that it takes the business that much longer to see a return on investment for that inventory, at least for that particular buyer.

Post your comments

Post Anonymously

Login

username
password
forgot password?

Register

username
password
confirm
email