A normal operating cycle includes the purchase or manufacture of inventory with credit purchases (accounts payable), the sale of inventory with credit sales (accounts receivable) and the payment of cash to suppliers and customers. It is a measure of the time taken to complete the purchase, sell the inventory and collect the cash. The perpetual inventory system keeps a running account of the available inventory. The periodic system of inventory measures inventory levels at periodic intervals. The gross operating cycle calculation does not take creditor deferral periods into account.
Calculate days inventory outstanding or DIO using the following formula:
Days inventory outstanding = (average inventory / cost of goods sold) * 365
DIO is a measure of the number of days inventory was turned into sales.
Calculate daily sales outstanding or DSO using the following formula:
Daily sales outstanding = (average accounts receivable / total credit sales) * 365
DSO is a measure of the age of the accounts receivable account.
Calculate days payable outstanding or DPO or using the following formula:
Days payable outstanding = (average accounts payable / cost of goods sold) * 365
DPO is a measure of the days taken by the company to pay off its accounts payable.
Combine the values determined in Steps 1-3 to calculate the gross operating cycle using the following formula:
Operating cycle = DIO + DSO - DPO (in days)
Use the trends implied by the final calculations to evaluate the health of your company.
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