Operating and financial cycle: definitive guide with concept, importance and calculation

Many managers and business owners often have difficulty assessing their business's finances. This tends to compromise decision-making and, consequently, the company's success.

After all, when there is no clear understanding of the cash flow inflows and outflows and the operation as a whole, it becomes more difficult to define strategies that bring significant returns.

For management efficiency to occur, it is essential to have full knowledge and control over the company's operational and financial cycle.

They refer to resource needs and financial movements, as well as the entire process that involves everything from purchasing raw materials from suppliers to receiving payments from customers and generating profit.

In the following lines, you will find a complete guide on what the operating cycle and financial cycle are , how to calculate them and practical examples to facilitate your understanding.

Continue reading and learn how the operational and financial cycle can help you make cash flow projections, analyze your company's need for loans and working capital, and ensure that it develops with financial sustainability.

Also, check out these 4 tips on how to manage the operational and financial cycle more efficiently:

1. Make a good budget plan
2. Reduce sales receipt times
3. Try to extend the deadline for payment to suppliers
4. Use technology to your advantage

What is a company's operating cycle?

The average amount of time it takes a business to finish the tasks involved in its economic activity is known as the operating cycle. Purchasing raw materials from vendors is the first step in the business's operating cycle. Next, the production of the goods begins, which are then stored and sold as soon as they are ready. Finally, after sales are made, the operating cycle ends with the receipt of the payment by customers.

In other words, the operational cycle comprises the interval between outflows to finance operations and inflows into the company's cash flow.

Ok. But how do you calculate the operating cycle?

The operating cycle formula is as follows:

CO = Average Storage Period (ASP) + Average Receiving Period (ARS)

Operating cycle: example

So that you can better understand what a company's operational cycle is and how it works, check out a practical example.

Let's assume that a wholesale company's products remain in stock for an average of 45 days (PME). Furthermore, the Average Receipt Time (PMR) is 28 days.

Therefore, we have:

• CO = 45 + 28
• CO = 73 days

In other words, the result of this calculation shows that the wholesale company's operational cycle takes, on average, 73 days to be completed.

The lower the CO result, the better. But wait a minute because we'll talk more about this in the next few lines.

What is a company's financial cycle?

The journey that money travels from supplier payments to sales earnings is known as the financial cycle. The financial cycle is the interval of time between cash inflow and outflow.

And how is the financial cycle calculated?

The outcome of the operating cycle determines how the financial cycle is calculated. The following is the financial cycle formula:

CF = Operating Cycle – Average Payment Period to Suppliers (PMPF)

And what happens if the result of the financial cycle is negative?

Contrary to what many managers and business owners may imagine, a negative financial cycle does not mean something bad for business . In fact, the shorter it is, the healthier and more financially sustainable your company tends to be.

When the financial cycle is negative, it means that the company does not make its payments before receiving the returns on the investment made in the acquisition of raw materials or ready-made goods.

In other words, the deadline given by suppliers was sufficient for the company to pay them with the money received from sales of its products.

The positive financial cycle is the most common among most companies. In this case, the company pays its suppliers before even receiving payment for its sales. This generates a deficit until the end of the cycle, which is when it finally receives the amount from the sales.

Financial cycle: example

Still taking the wholesale company we mentioned earlier as an example, we have an operational cycle of 73 days.

Let us assume, then, that the Average Payment Period to Suppliers (PMPF) is 15 days.

Therefore, we have:

• CF = 73 – 15
• CF = 58 days

Bringing this result to an annual analysis, it is possible to conclude that the wholesale company's inventory turned over 6.3 times in one year (365/58).

Ideally, managers should be able to reduce the financial cycle as much as possible so that inventory can be turned over more often and more money can come in.

Therefore, the wholesale company in our example must negotiate longer payment terms with its suppliers and reduce the operating cycle so that there is more cash on hand.

Operating and financial cycle: why is it important to understand them?

Now that you know what a company's operational and financial cycle is and how the calculations work, the question remains: why is it important to understand these cycles?

The relevance of understanding an organization's operational and financial cycles lies in the fact that, if they are not in balance, the company will not be able to sustain itself financially for a long time .

Furthermore, these cycles make clear the importance of quality inventory management.

Without a well-managed inventory, the operational cycle will tend to be longer, resulting in an accumulation of goods and a reduction in cash revenue.

A high operating cycle is a sign that there is little stock output and little money circulation.
Furthermore, very full stock with little sales can generate losses with space rental, maintenance and labor.
Ideally, these cycles should be reduced so that they can rotate more times during the year.
With this in mind, it is also worth highlighting the importance of knowing how to negotiate more favorable terms with your suppliers. This is a variable that directly affects the result of your financial cycle; the longer the term for payment to suppliers, the shorter the financial cycle will be.
In short, the operational and financial cycle are important in order to improve asset turnover and increase the inflow of cash into the company's cash register.

4 tips for more efficient management of the operational and financial cycle

One of the best ways to manage both the operational and financial cycles is by integrating information from each of them with the help of technology.
Check it out!

1. Make a good budget plan

With a well-structured budget plan , it is possible to make revenue and expense projections and better define the distribution of resources. This type of document guides decision-making and allows greater control over the operational and financial cycle.

2. Reduce sales receipt times

As mentioned above, it is important to seek to receive your sales receipts as early as possible. This helps to reduce the operational cycle and make your turnover more agile.

3. Try to extend the deadline for paying suppliers

Also try to extend the payment deadlines for your suppliers as much as possible. This way, you will have a longer window for the value of your sales to enter the cash register and you will not be in the red.
Remember that this variable is essential for maintaining a sustainable financial cycle.

4. Use technology to your advantage

Business management software (ERP) can be a strong ally for managing the operational and financial cycle.

This type of system is capable of optimizing a series of tasks , allowing managers to focus more on strategic aspects of management.

ERP software can, for example, issue alerts about stock levels and payment deadlines that are about to expire.