Period of operating cycle implies that total sum of number of days included in the various stages of operation commencing from the purchase of raw materials and ending along with collection of sale proceeds by debtors after adjusting the number of day's credit permitted through suppliers. Hence, the operating cycle is the total period concerned in different stages of operations, that may be computed by using the subsequent formula as:
OC = M+W+F+D-C
Here, OC = Operating Cycle Period;
M = Material Storage Period;
W = Work in Process or Conversion Period;
F = Finished Goods Storage Period;
D = Debtors Collection Period;
C = Creditors Payment Period.
Material Storage Period (M) = Average Stock of Raw Materials/Daily Average Consumption
Or
((Opening Stock + Closing Stock)1/2)/(Material Consumed for the Year/365)
WIP or Conversion Period (W) =
Average Stock of Work-in-Process/Daily Average Production Cost
OR
((Opening WIP + Closing WIP) / 2)/(Total Production Cost / 365)
(a) Total Factory or Production Cost is computed by adding opening stock of work-in progress into the total of direct material, factory and labour overheads and deducting by this the closing work-in-progress. Depreciation is not included being a non-cash item.
(b) Occasionally the Conversion Period is also termed as the Production Cycle Period. In such case, information regarding this period is specified, then conversion period is not to be computed with the above formula.
Finished Goods Storage Period (F) =
Average Stock of Finished Goods/Daily Average Cost of Goods Sold
OR
((Opening Stock + Closing Stock) / 2)/(Total Cost of Goods Sold / 365)
Cost of Goods Sold is computed by adding excise responsibility with the factory cost after adjusting closing and opening stock of finished goods. Administration or selling and distribution expenses are not noticed in it, as, in financial accounting, stock of finished goods is importance at factory or production cost.
Debtors Collection Period (D) = Average Debtors/ Credit Sales per Day
OR
((Opening Drs. + Closing Drs.) / 2)/(Total Credit Sales / 365)
Creditors Payment Period (C) = Average Creditors /(Total Credit Purchases / 365)
OR
= ((Opening Crs. + Closing Crs.) / 2)/(Total Credit Purchases / 365)
Notes: Regarding the above formula the subsequent points are worth noting
- The 'Average' value in the numerator sets for the average of closing and opening balance of the respective items. Though, if only the closing balance is obtainable, then even the closing balance might be considered as 'Average'.
- The figure '365' shows number of days in a year. Although, there is no hard and rapid rule and occasionally even 360 days are taken.
- In the computation of M, W, F, D and C, the denominator is computed at cost basis and the profit margin is not included. The purpose being that there is no investment of funds in profits.
- In the lack of any information, total purchases and sales are considered as credit.