FREE online courses on Financial Ratio Analysis - Efficiency Ratios - Operating Cycle

 

Now that we have calculated the number of days for receivables and the number of days for inventory, we can estimate our operating cycle. Operating Cycle = Number of Days in Receivables + Number of Days in Inventory. In our previous Examples, this would be 32 + 228 = 260 days. So on average, it takes us 260 days to generate cash from our current assets.

 

If we look back at our Current Ratio, we found that we had 2.5 times more current assets than current liabilities. We now want to compare our Current Ratio to our Operating Cycle. Our turnover within the Operating Cycle is 365 / 260 or 1.40. This is lower than our Current Ratio of 2.5. This indicates that we have additional assets to cover the turnover of current assets into cash. If our current ratio were below that of the Operating Cycle Turnover Rate, this would imply that we do not have sufficient current assets to cover current liabilities within the Operating Cycle. We may have to borrow short-term to pay our expenses.