Despite the numerous financial ratios and analysis available to measure the business performance, we have found that the operating cycle is the single measure that enables understanding of how quickly you are transforming your resources into cash.
Operating Cycle is the sum of Stock Turnover and Debtor Collection.
This measure should be consistently monitored and improving the speed at which you turn your stock into cash the less working capital you require and the quicker you can grow the business.
After establishing your operating cycle, it is important to find out how long it takes for the cash to be recovered from the sale of your goods after you have paid for them. This is the cash cycle. The shorter the cycle the less cash you need to run the business. In simple terms, the cash cycle starts when you pay your supplier and ends when your customer pays you. The operating cycle starts with acquiring of inventory or raw material and ends with receipt of payment from your customer.
As an example, if the operating cycle of your business is 80 days (the period from receiving the inventory from supplier to you collecting money for the sale from the customer) and you pay your supplier on average 30 days, it means your cash cycle is 50 days (ie. operating cycle-payment period).
To improve your business, reduce your cash cycle and improve both cash flow and profitability.