Operating cycle: 7 questions to understand everything

So here is the second article on the Operational Management courses for the BTS MCO. I will tell you about the operating cycle by answering 7 questions to understand everything.

Here are the 7 questions I will answer and which you can click on to go directly to the desired question:

1. What is the operating cycle?
2. Who are the partners of a UC?
3. What are the components of the operating cycle?
4. What are the different operations in the UC?
5. What are the physical flows and financial flows in the operating cycle?
6. How to calculate the operating cycle time?
7. What is the link between the operating cycle and the WCR?

Question #1: What is the operating cycle?

The operating cycle is the regular repetition of current business operations related to operations. It is therefore the set of operations carried out from the stage of purchasing goods and/or services to their sales.

 

Question N ° 2: Who are the partners of a UC?

Of course, before listing the different partners of a business unit, you must be convinced that a company must necessarily interact with partners, that is to say with third parties.

There are different categories of partners within a company:

 

Customers

These are the partners to whom the company sells its goods, finished products, or services. A customer may have the legal form of a natural person or a legal entity.

 

Brands

Suppliers enable the smooth running of the company's operations because they provide the goods, raw materials or even services necessary for the operation of the UC's activity.

 

Banking institutions

This partner is essential in the life of the company because it allows it to obtain financing.

In fact, the business unit may be granted loans in order to make investments (purchase of a new machine, carrying out major works, extension of its infrastructure, etc.).

Of course, in exchange, the financial institution is remunerated by collecting interest in the form of a percentage based on the amount borrowed and the repayment period.

 

The state

This partner is special because it allows you to obtain funding in the form of grants.

These can have different reasons such as the establishment in a particular geographical area, the exploitation of an activity linked to the improvement of the environment.

But the State and other organizations also collect, and not least, taxes, duties and contributions.

 

Employees

Of course, a company without employees, and therefore without a workforce, cannot function.

Employees must be trained and motivated in order to create dynamics within the business unit.

There are many forms of motivation, such as the payment of bonuses, salary increases or even obtaining bonuses.

 

Shareholders

They are financiers because they provide funds in order to take a share of the company's capital. They therefore make it possible to increase the capital of the business unit.

In return, they receive remuneration in the form of dividends when the company makes a profit.

 

Question N ° 3: What are the components of the operating cycle?

The components of the operating cycle are different depending on the company's activity.

For an industrial company – For a table manufacturer, the operating cycle is made up of 5 stages:

 

For a commercial business – For a chair dealer, the operating cycle is made up of 3 stages:

 

For a service provider company – For a clothing rental agency, the operating cycle is made up of 3 stages:

 

Question N ° 4: What are the different operations in the UC?

Within a company, we see 3 types of operations that are reproduced cyclically. In fact, they are reproduced regularly.

We distinguish:

Le investment cycle

It concerns operations related to company investments such as the acquisition of a new machine or the purchase of stock market securities. These investments have an impact on the long term, that is to say over several years.

Le a cycle of exploitation

It concerns operations related to the current, normal and daily activity of the company such as the purchase of goods, storage or sale of finished products. These usual operations of the company have an impact on the short term, that is to say on less than a year.

Le funding cycle

It concerns operations related to the financing of the business unit such as a loan from a credit institution or a contribution from partners. Just like the investment cycle, these operations have an impact on the long term, that is to say over more than one year.

 

Question N ° 5: What are the physical flows and financial flows in the operating cycle?

A flow is a movement, a circulation. In business management, in the operating cycle, we distinguish between physical or real flows and financial or monetary flows..

The physical flows relate to the actual movements or circulation of goods or services between the business unit and its partners.

So these are purchases of raw materials, sales of goods, etc.

The financial flows relate to the movements or circulations of the various regulations of physical flows within the commercial unit.

These are therefore disbursements linked to the payment of supplier invoices but also to collections which are linked to the payment of customer sales invoices.

 

Question No. 6: How to calculate the duration of the operating cycle?

The duration of the operating cycle

To calculate the operating cycle time of a business unit, three elements must be taken into consideration: the activity of the business unit, the stock management of the company and finally payment deadlines to its suppliers and collection of its customers.

Concretely the duration of the operating cycle is the period between the act of purchasing the goods (or finished products, or even raw materials) and the collection of sales of the goods, finished products or services.

Instead, look at an example of calculating an operating cycle time to make it more concrete for you:

 

Question No. 7: What is the link between the operating cycle and the WCR?

What is the BFR?

Working Capital Requirement (WCR) is the amount that the business unit must have permanently in order to cope with the gap that exists between customer receipts and supplier invoice disbursements.

The working capital requirement therefore makes it possible to finance the company's operating cycle.

 

How to calculate the WCR?

To calculate the working capital requirement, you can use the following formula:

Stocks + Customer receivables – Supplier debts

The numerical elements of the formula are found in the company's balance sheet.

Here is an example of calculating working capital requirements.

We provide the figures from the company's balance sheet:

Inventories of goods: €14 / Accounts receivable: €000 / Accounts payable: €18

So here is the calculation by applying the previous formula:

€14 + €000 – €18 or €000

The working capital requirement therefore amounts to €25.

You must always interpret your result in order to put it into context.

With the little information we have, we can still say that the business unit needs €25 to finance its operating cycle.

Here is another possible interpretation: the UC must advance the sum of €25 daily in order to meet its activity.

 

How to calculate the duration of the WCR?

The duration of the working capital requirement (WCR) is calculated by taking into account the same elements that make up the WCR formula. But this time, it will be necessary to take into account the durations of each element and not the amounts.

I will give a numerical example so that you can understand.

 

explanations:

First, it is necessary to take into account the periods during which the business unit does not have the funds for the relevant accounting items. This is the case for the storage period and the duration of the customer receivables item.

In fact, the company does not have the funds from the sale of inventory nor does it have the amount of receivables owed by customers.

As for the remaining item, the duration of the supplier credit, it is money that the company has since it is a debt.

 

How to predict the WCR?

It is possible to assess the working capital requirement. To do this, you simply need to know the forecast accounting elements.

The positions concerned are as follows:

• The forecast turnover including tax
• Forecast purchases including tax
• Average customer credit period
• The average supplier credit period
• The average storage time

I will take an example so that you can see the calculations in detail.

Forecast turnover including tax: €2

Estimated purchases including tax: €1

Average customer credit period: for a period of 15 days the amount is (2/500 days) x 000 days or €360

The average supplier credit period: for a period of 20 days the amount is (1/900 days) x 000 days or €360

Average storage period: for a period of 30 days the amount is (1/900 x 000 days/1,2 days) or €30

By applying the BFR formula, we obtain the following calculation:

131 + 945 – 104 = €166,66

 

How to reduce the BFR?

The BFR can be reduced in several ways:

• By reviewing stock management so that it is as short as possible;
• By negotiating very short deadlines with its customers;
• By negotiating significant deadlines with its suppliers;
• By acting on several elements at the same time.

 

What is RFR?

A working capital resource (WCR) is the amount of money that a company has available on a daily basis for its core business. Its operating cycle is financed and the business unit thus has a surplus.

Sometimes it happens that the result of the working capital requirement formula gives a negative amount. In this case, it is a positive point for the business unit.

In fact, it is no longer a question of a need for working capital but of a working capital resource (RFR) or a funding resource. Collections from customers of sales of goods by the company are made before disbursements relating to payments of supplier debts.

 

How to calculate the duration of the RFR?

The duration of the working capital resource (WCR) or financing resource is calculated by taking into account the same elements that make up the WCR formula. But this time, it will be necessary to take into account the durations of each element and not the amounts.

I will give a numerical example so that you can understand.

 

Conclusion

To go further, you should know that the operating cycle can also be financed externally.

In fact, it can be financed by a financial institution in different ways: overdraft facility, authorized overdraft, campaign credit or with the help of discounts on commercial paper.

If you want to apply everything you have just learned, I strongly encourage you to read the article on corrected management exercises entitled 5 Corrected Exercises on the Operating Cycle and WCR.

There you have it, now that you have read these few lines, you have become an expert on the subject of the operating cycle.