The operating cycle is defined as the process by which a company spends cash to generate revenues and receives cash payments at the time of sale or in the future by collection on an account receivable. Depending on the nature of the business, the process and length of the operating cycle will vary. For example, a small business that makes arts and crafts to sell at a local market may have a very short operating cycle if it makes its crafts and sells them for cash shortly afterward at the market. A business that builds homes may have a longer operating cycle, as it takes longer to buy all the supplies to build a home, actually build it, and then sell the home and collect cash from the buyer.
The operating cycle of a merchandising business involves three transactions:
1. Purchase of merchandise from suppliers
2. Sale of merchandise to consumers on account or for cash at the time of sale
3. Collection of payments from accounts receivable customers
It is important to note that there are several types of businesses, such as merchandising, manufacturing, or service businesses. Manufacturers use materials to make things that they then sell. Service businesses generally don't make things; rather, they provide services. The operating cycles of a service business, manufacturing business, and merchandising business all differ slightly. For example, a merchandising business must purchase goods to resell to consumers, while service businesses deliver expertise, advice, or a professional skill set.
The operating cycle length will vary from one business to another, depending upon the nature and shelf life of the products being sold. For example, grocery retailers tend to have a shorter operating cycle due to the shelf life of their merchandise. On the other hand, car dealers can display vehicles for months until they are sold, as vehicles do not have an immediate expiration date.