Thread: Operating Cycle

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    Operating Cycle
    Having a hard time understanding: How does the operating cycle of a company affect the company's financial standings and its financial statements?


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    I guess the answer is it depends.

    I'm making the assumption here that by operating cycle you are referring to a business affected by seasonal swings, for example? In which case, of course, the end of the financial year is a snap-shot in time, and your books will represent the picture as it stands at that moment.

    If that's an issue (eg: if you are looking to dispose of the company, or perhaps applying for something based on fiscal return, or whatever) then I understand that there is some sort of provision for changing the EOY. I could be wrong on that, as it is likely to be subject to whatever country you are based in, but it is something to check.


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    Here's a specific example
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    Maybe this example will provide you with a mental picture. This is only an example. Any of you bankers out there don’t get bent if the rules have changes in this example. Don’t focus on the accuracy of the workings or banking procedures of this example, but the CONCEPT we're teaching here. This is to SHOW HOW financial statements can affect a business during specific times of the year.

    In the following example, the banks “Operating Cycle” is directly controlled by its ending Fiscal Tax Year. A business year either ends in a Calendar Year (January 1 thru December 31), or from a date they determine when setting up. This is called a Fiscal year. An example of a Fiscal Year would be July 1 (The start of their business year) and ending June 30)

    Let's assume a Bank has a Fiscal year starting April 1 and ending March 31.

    They are permitted to borrow money from the Feds based on their liquid assets. For sake of argument, let’s say they have $1,000,000 in deposits so the Feds permit them to borrow 10 times that amount or $10 million dollars, which they will loan out at a higher interest rate than they paid.

    Suppose they have 2 foreclosures, houses they have loaned $50,000 each on. They had to foreclose on them so their equity is $100,000, but tied up until they sell the houses. They own these houses called REOs (Real Estate Owned).

    If you owned these 2 houses and suppose they were still only worth $50,000 each, you would show a net worth of $100,000 for them.

    A bank is allowed to borrow based on its liquid assets and REOs are NOT considered liquid assets

    Lets assume it is NOW March 1st and they have one month before their Fiscal business year ends. And let's assume that they will be borrowing as much money as they can get from the Federal Gov. after they end their Fiscal year in a few weeks. So, they want to have as MUCH liquidity (available cash not equities) on hand as possible. That means they want to QUICKLY get rid of the 2 REOs making that cash liquid. They CAN'T BORROW against the equity, so these REOs are a negative to their balance sheet IN THIS SITUATION.

    Suppose they currently have $900,000 in deposits permitting them to borrow 10 times that amount $9,000,000

    But, if they sell the two houses, get their $100,000 back out of it QUICK, they can borrow 10 times $1,000,000 for a total of $10,000,000. That's an extra million they can loan out.

    If it was 2 months later, in may, and suppose they couldn't borrow any more until their next financial statement ending at the end of their next Fiscal tax year, and they just got 2 more REO foreclosures, each tying up $50,000 for a total of $100,000, this won't be much of a negative to them at this time. They just need them gone, showing more liquidity (available cash) next year near the end of their tax year.

    Simply put, the REOs aren't much of a problem now, but will be near the end of their tax year. Timing here is everything. In the past, when I bough REOs from banks, I would wait until 4-6 weeks before the end of their tax year and then start making offers. They were MUCH MORE motivated at this time, than a week after the end of their tax year.

    Regards,
    Maverick


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    Maverick's example is dead on. The business's operating cycle influences the company's financial statement because at one end of it, the cash is moved out of assets and into liabilities. Maverick does a great job of illustrating the concept, so I won't repeat it. But there is a definite impact.


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    The operating cycle starts with the availability of cash. Then you would purchase/manufacture goods and provide them to customers. Customers would either pay in cash or settle for a credit term. The cycle ends when you collect cash from the customers. Then it revolves again. The main element that the operating cycle has an effect on is the liquidity of the entity. Liquidity is the ability of the entity to convert its noncash assets into cash. The more liquid the entity is, the better. If you have a long operating cycle, cash management would be extremely vital.


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    That's also a valid point Auror. The operating cycle for each business, meaning the time it takes for a business to turn it's cash back into cash after manufacturing a product, will differ. The longer this cycle is, the more important it is for a business to manage it's cash flow. Not only does it impact their financial statements, it has a direct impact on their ability to do business, which can hurt them in the long run. This is why a lot of businesses wind up taking loans out to cover the shortfall.


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    Operating Cycle is a cycle in which the stock of the business gets converted into cash when sold out to its customer. And then this cash is re-invested to purchase new stock of the business and this stock is sold again and the cycle continues numerous times during the lifetime of the business. Now the volume of stock sold in this operating cycle is the turnover of the business and larger the turnover, the more will be the value of the business and will result in higher profits.


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    Quote Originally Posted by pahagwl View Post
    Operating Cycle is a cycle in which the stock of the business gets converted into cash when sold out to its customer. And then this cash is re-invested to purchase new stock of the business and this stock is sold again and the cycle continues numerous times during the lifetime of the business. Now the volume of stock sold in this operating cycle is the turnover of the business and larger the turnover, the more will be the value of the business and will result in higher profits.
    There are multiple ways to describe the operation cycle. There are also a lot of levels of details. The cycle you mentioned is basically the most basic cycle you can describe.


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    I am sure that the local health office will have some sort of record. It simply is really nice to have. - Steven C Wyer


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    An operating cycle refers to the time it takes a company to buy goods, sell them and receive cash from the sale of said goods. In other words, it's how long it takes a company to turn its inventories into cash. The length of an operating cycle is dependent upon the industry. The operating cycle is the sum of the following: the days' sales in inventory (365 days/inventory turnover ratio), plus. the average collection period (365 days/accounts receivable turnover ratio)


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