Financial metrics are very important when it comes to analyzing how efficient your business is. Both cash cycle and operating cycle are a great way to measure your businesses financials. Often people think they are the same thing. While they are very similar, they have small differences that make them each very useful.
What do they consist of?
Both the operating and cash cycle both consist of Days Inventory Outstanding and Days Sales Outstanding. Days Inventory Outstanding (DIO) is a metric that tells you the average days that a company holds inventory before turning it into sales. A high or low DIO can say a lot about a business. Days Sales Outstanding (DSO) is the measurement for the average number of days it takes a company to collect payment from a sale. If your DSO is trending one way or another is a sign something has changed. Where they differ is on the cash cycle. The cash cycle has another measurement on it called Days Payable outstanding. Days Payable Outstanding (DPO) is a metric that indicates the average amount of time in days that a company takes to pay its bills and invoices. This could include things like suppliers or financiers. This also shows how well a company can manage its funds.
What is an Operating Cycle?
So, what is an operating cycle? The operating cycle is the amount of time it takes for a company to acquire inventory, sell the inventory, and receive payment from the customers in exchange for the inventory sold. The length of the operating cycle depends on the industry. Overall, an operating cycle can give a good picture of whether a company is able to pay off any liabilities. When a business owner understands the operating cycle better, they can make better decisions for the company.
The operating cycle is calculated by adding together your DIO and DS.
What is a Cash Cycle?
A cash cycle is very similar to the operating cycle but slightly different. Rather it measures the amount of time a company’s dollars are being used for production or sales purposes before being converted into cash. The cash cycle is where the days payable outstanding comes in. The cash conversion cycle is useful because it helps determine how well a company can provide good or services and collect payment without extending credit or holding inventory for too long. Cash cycle is also a great thing to measure because it will provide a deeper look into the financial health of a business.
The cash cycle is calculated by adding DIO and DSO then subtracting DPO
There is another cycle involved in a business that is even more important. If you would like to learn about it and how it can improve your financials then join our KPI course today. Overall it is very important to understand the numbers of your business to truly get be successful. Click the link below to learn more.