Although Cash and Operating Cycle are both the measure as in what time period, money flows back into business, but they both differs marginally in terms of aspects of cash flow they measure:
Operating Cycle:
This metric indicates the amount of time it takes for the company to get the money invested in inventories back into cash. The metric is purposely called operating cycle as the process of purchasing raw material, processing it, selling the items and using the cash recovered from customers and then again using the cash generated to purchase the raw material will go on until the company exists. Important to note, every company desires to have shorter operating cycle as it indicates that capital is tied for a lesser period of time. Operating Cycle of a company is calculated using the following formula:
‘’Operating Cycle = Days' Sales of Inventory + Days Sales Outstanding’’
Cash Cycle:
Cash Cycle also known as Cash Conversion Cycle is the amount of time is time between cash outlay and collection of cash. In other words, it is just an addition to Operating Cycle as once the company process raw material, sells good on credit, collects cash from accounts receivable, it finally settles the accounts payable due on its name. Just as operating cycle, every company would desire for a shorter cash cycle as it indicates the better liquidity position. Overall, this measure indicates how efficient a company in managing its working capital. Cash Cycle is calculated using following formula:
‘’Cash Conversion Cycle (CCC) = Days Sales of Inventory + Days Sales Outstanding- Days of Payable’’
Importance for Finance Managers:
It is really important for a finance manager to understand both these terms as they are directly related to survival of the company. This is because if the management does not look at these metrics and allow them to go higher, the company may soon face liquidity crisis. Thus it is always advisable to maintain a short operating cycle and cash cycle as doing so will improve the liquidity position and will also minimize the inventory storage and depreciation costs.
Works Cited
Cash Conversion Cycle. (n.d.). Retrieved November 18, 2014, from http://www.readyratios.com/reference/asset/cash_conversion_cycle.html
Nordmeyer, B. (n.d.). The Difference Between Operating & Cash Conversion Cycles. Retrieved November 18, 2014, from http://smallbusiness.chron.com/difference-between-operating-cash-conversion-cycles-24738.html
Operating Cycle. (n.d.). Retrieved November 18, 2014, from http://accountingexplained.com/financial/ratios/operating-cycle
