How to calculate the Operating Cycle for a manufacturing firm?

Well, you can calculate the Operating Cycle as following:

(a) Raw Material Storage Period

(i) Calculate the cost involved in annual consumption of raw materials

(ii) Calculate average daily consumption of raw materials by dividing (i) by 360 days

(iii) Calculate average stocks of raw materials as following:

(Raw material at the beginning of the year + Raw material at the end of the year) divide by 2

(iv) Divide average stocks of raw material by daily average consumption i.e. (iii) divide by (ii) resulting in no. of days of raw material storage say X1 days.

(b) Work in Progress (WIP) Period (also called Conversion Period)

(i) Calculate annual cost of production : Take opening WIP + consumption of raw materials during the year + other manufacturing cost like salaries, electricity bills etc. + depreciation – closing WIP

(ii) Calculate average daily cost of production by dividing (i) by 360 days

(iii) Calculate average stock of WIP as following: 

(WIP at the beginning of the year + WIP at the end of the year) divide by 2

(iv) Divide average stock of WIP by average daily consumption of WIP i.e. (iii) divide by (ii) resulting in no. of days of raw material storage say X2 days.

(c) Finished Goods (FG) Storage Period

(i) Calculate annual cost of sales : Opening stock of FG + cost of production as calculated above at b(i) + Excise Duty payments + Selling Cost + General Administrative Cost + any Finance Cost -  Closing stock of FG

(ii) Calculate average daily cost of sales by dividing (i) by 360 days

(iii) Calculate average stock of FG:

(FG at the beginning of the year + FG at the end of the year) divide by 2

(iv) Divide average stock of FG by average daily cost of sales i.e. (iii) divide by (ii) resulting in no. of days of FG storage say X3 days.

(d) Average Collection Period

(i) Calculate credit sales during the year

(ii) Calculate average daily credit sales by dividing (i) by 360 days

(iii) Calculate average balance of Debtors (also called Sundry Debtors)

(Sundry Debtors at the beginning of the year + Sundry Debtors at the end of the year) divide by 2

(iv) Divide average Sundry Debtors by average daily Sundry Debtors i.e. (iii) divide by (ii) resulting in no. of days of Average Collection Period say X4 days.

(e) Average Payment Period

(i) Calculate annual credit purchases

(ii) Calculate average daily credit purchases by dividing (i) by 360 days

(iii) Calculate average balance of Creditors (also called Sundry Creditors)

(Sundry Creditors at the beginning of the year + Sundry Creditors at the end of the year) divide by 2

(iv) Divide average Sundry Creditors by average daily Sundry Creditors i.e. (iii) divide by (ii) resulting in no. of days of Average Payment Period say X5 days.

Now calculate the Operating Cycle as following:

Gross Operating Cycle in days: X1 + X2 + X3 + X4 = Say G1 days

Net Operating Cycle in days :  G1 days – X5 days

You will appreciate from the all the components are basically the Levers of Working Capital. The better a firm manages each of the Lever the better control of the firm will have on its Working Capital. A firm may plan its policy on each no. of days for each of the above component and monitor from time to time. Any deviation from the policy Standards will lead to scrutiny in order to take remedial actions.