#operatingcycleofworkingcapital

[learningperspectives]

The scene that you just saw shows how Moti (played by Amitabh Bachchan) is extracting sap from palm trees. This sweet drink is later used for brown sugar/jaggery production. Mahjubhi (played by Nutan) pours the hot liquid into molds to cool it down and  make blocks of jaggery/brown sugar or gud (in hindi).

In this blog, Learning Perspectives explore the meaning of operating cycle.

What is Operating Cycle?

Operating cycle is a term used in organizations. It is also called the cash conversation cycle. Operating cycle is the time between the acquisition of an asset for processing and its conversion into cash. Similar to the scene we saw, purchasing the raw material, processing it to make a finished product, selling it and converting into cash and cash equivalents.

Operating cycle is determined for each class of business separately. For example, if someone has 2-3 businesses dealing with manufacturing, construction and or trading. Then operating cycle will be determined for each business separately.

The scene that you saw shows palm trees, which is the raw material from which sweet sap is being extracted out of it. Then it goes through the step of processing. This sap is being boiled to make sugar syrup to form jaggery. Entire process of acquiring the palm trees to the formation of jaggery till earning cash from it. This cycle is referred to as the operating cycle.

📷

Operating cycle helps in understanding how much time does a company take:

To sell its inventory.

Collect bills

Pay suppliers

Calculating Operating Cycle:

Formula for calculating operating cycle is inventory time in storage plus time to collect cash from sales.

Similar to the scene we saw, once jaggery/ brown sugar is prepared, it remains with Moti (Amitabh Bachchan) till it is sold and he receives cash by selling it.

Operating Cycle= Period of inventory storage + Account receivable period

Another way of writing this can be:

Operating Cycle = 365/Average Inventory + 365/ Average receivables

where, Average inventory= Beginning+Closing Inventory/2

Average Receivables= Beginning+Closing Receivables/2

If the operating cycle of a company is more than 12 months, i.e.

Time taken to purchase the raw material- 3 Months

Processing of raw material- 6 months

Held in Inventory as finished good- 3 months

Finished good converted into accounts receivables- 3 months

Accounts receivables Realized

If a product of a company goes through the above steps and it takes them more than 12 months, then all liabilities are shown as current liabilities as if they are due for settlement in 15 months.

Written by: Ms.Gitika Chandra