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Operating Cycle | Gross vs Net Operating Cycle | Definition | Formula - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell ican Friends today we have going to learn a topic which is known as
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operating cycle one of the vital thing a
company goes through because they always
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have to keep a track on the operating
cycle without if they are ignorant about
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that or if they don't pay attention to
the operating cycle they may get into a
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disaster situation if it is going beyond
the hands or it is going beyond the
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stipulated number let's see
Amazon and Toyota Motors cash conversion
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cycle which is the operating cycle if
you see the operating cycle of Toyota
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Motors is 96 days whereas the operating
cycle of Amazon is -18 days that's
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a huge difference it's like one is in
the positive one is negative let's
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understand this see what first first we
need to understand what is the operating
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cycle this is the first and the foremost
thing that we need to understand the
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operating cycle of the cash cycle is of
a company is an activity the ratio it is
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in activity ratio measuring the average
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period of time required for turning the
company's inventories into cash the
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process of producing basically all
purchasing inventory selling finished
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goods receiving cash for the customers
and then using the cash to purchase
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produce inventories again is
never-ending cycle so as long as company
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remains operational so what we saw over
here cash cycle of Toyota Motors is
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96 day is Amazon of 18 - 18 days which come here of this - is doing better so
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for the same we need to look at one
diagram see the diagram over here the
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raw material procurement this
the operating cycle diagram first there
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is a raw material procurement it is
processing it it goes into walk in
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progress you come out with the finish
good you sell them so you have
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receivables receivable means your taters
because you have sold them the amount is
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yet to be received and post facto after
a month or two you get your cash you use
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that cash again to procure zero material
so this is the whole operating cycle
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over here your creditors will be
involved over here your data's are
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involved and in between it's the
inventory which is involved from raw
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material to the finished goods so this
is the operating cycle basically this
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cycle you know provides an insight on
the operating efficiency of the company
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now this is useful in estimating the
cash cycle which comes in the middle in
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the working capital requirement for the
maintaining the growth or of the
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organization's operation now I'll say
that you know shorter shorter cash cycle
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indicates that the company recovers its
investments quicker and hence has less
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cash tied up in the working capital
however if the operating cycle varies
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across an industry you know sometimes
extending it to more than year for
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some sector for example like
shipbuilding shipbuilding companies
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right so let's understand the gross and
the net operating cycle see the cross
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operating cycle is which is also known
as your GOC this is also known as your
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GOC is a time period after the raw
material purchases after the raw
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material is purchased still its
transformation to cash so as for the
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operating cycle formula the time can be
divided into inventory holding period
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and the receivables or the datas
collection period right here inventory
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holding period comprises of raw material
holding period walking progress process
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and the finished goods holding period
and so on and so forth now let's talk
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about the gross operating cycle its
formula goes something
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this the inventory inventory holding
period plus you need to add any
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receivables or the data's holding period
that is your gross this is your cross
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operating cycle so raw material this
inventory holding period includes your
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raw material holding period raw material
I just said you know abbreviated form no
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material holding period work-in-progress
holding period and you have your final
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data's which is your receivable
collection period when we talk about the
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net operating cycle it refers to the
time period between paying of the
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inventory and the cash collected from
the sale of the receivable so it is also
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known as your cash conversion cycle it's
also known as triple C so the net
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operating cycle formula goes something
like this
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is equal to your cross operating cycle
less whatever payments are the creditors
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payment period that you do right so the
net OC is considered a more logical
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approach since payables are viewed as
the source of operating cash or
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operating cycle in working capital for
the company now let's do some operating
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cycle calculation first rate days of the
outstanding period days of outstanding
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period this is the first calculation
that will you know the days of the
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outstanding periods is is basically the
average number of days that is required
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for the company to convert its inventory
into sales right a lower di Oh speaks of
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the efficient use of the inventory since
it signifies the lower holding period
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and little chance of the inventory
become obsolete
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so like automobile companies usually
maintain just-in-time approach the JIT
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approach production system by
maintaining minimum inventory levels and
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lower dio however some companies may
choose higher dio to serve to service
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customer order at a shorter time and
those maintain a competitive
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so dio is equal to 365 days divided by
the inventory turn over right this is
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the formula now the second is their days
of days of sales outstanding days of
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sales outstanding so the days of seats
outstanding of the receivable collection
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period is the average number of days
taken by the company to collect the cash
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from the credit sales it gives an
indication to the efficiency of the
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collection department and bargain power
of the salon while you know the lower DSO
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o it shows that you know increases the
cash flow and liquidity in a higher DSO
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may indicate less aggressive terms to
boost sales but could run the risk of
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the higher bad debts the formula for DSO
goes something like this the DSO is
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equal to 365 days upon the receivable or
the leaders turnover okay next is third
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which is the Days payable these people
outstanding now the Days payable outstanding or
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the creditors payment is period is the
average number of the days that is taken
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by the company to pay its invoices from
trade creditors so the DPO gives an
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indication of the efficiency in the cash
flow management of the company while
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longer payments period would leave the
hire a fee or free cash flow with the
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company so the future credit terms may
be less favorable for the company and
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discounts for the timely payments may
not be available so if the DPO of the
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company dpo if that is if this is lower
than the industry benchmark that would
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indicate the company is not using its
cash in his efficiency as it compares
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compared to its competitor so the DPO
formula is equal to 365 days divided by
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the
payables no no let's look at the cash
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conversion cycle of apple you know what
we note that the cash cycle of the apple
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over here is negative now the apple days
inventory outstanding which is 6 days
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and apple has streamlined the product
portfolio and their efficient contract
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manufacturers deliver product quickly
the apples these sales outstanding is
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standing at the 50 days Apple has a
dense network of the retail stores where
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they get paid mostly by cash or credit
cards and apples these payable
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outstanding is standing at 101 days
because of the big orders to the
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suppliers Apple is able to negotiate
better in terms of credit period so if
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you just make the calculation 50 plus 6
minus 101 which is minus 45 days right
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that is the negative cash cycle I hope
you have got a great insight regarding
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this topic so that's it for this
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