Operating Cycle Mathematical Explanation - QS Study

Operating cycle is a measure of the operating efficiency and working capital management of a company. A short operating cycle is good as it tells that the company’s cash is tied up for a shorter period.

Another useful measure used to assess the operating efficiency of a company is the cash cycle (also called the cash conversion cycle).

Formula

Operating Cycle = Days’ Sales of Inventory + Days Sales Outstanding

Days sales of inventory equals the average number of days in which a company sells its inventory. Days sales outstanding on the other hand, is the period in which receivables are realized in cash.

An alternate expanded formula for operating income is as follows:

Example:

Walmart Stores Inc. (NYSE: WMT) is all about inventories. Find its operating cycle assuming all sales are (a) cash sales and (b) credit sales. You can use cost of revenue as approximate figure for purchases (i.e. no need to adjust it for changes in inventories).

Solution:

Part (a)

Days taken in converting inventories to accounts receivable = 365/352,488*42,259 = 43.75
Since there are no credit sales, time taken in recovering cash from accounts receivable is zero. Customers pay cash right away.
Operating cycle is 43.75 days and this represents the time taken in selling inventories.

Part (a)

There is no change in days taken in converting inventories to accounts receivable.
Days taken in converting receivables to cash = 365/469,162*6,353 = 4.92
Operating cycle = days taken in selling + days taken in recovering cash = 43.75 + 4.92 = 48.68
It should be compared with operating cycle of Walmart Competitors, like Amazon, Costco, Target.