- One of my favorite things in accounting
is to take these two ratios,
day sales and inventory and average collection period,
and add them together.
That will tell me a company's operating cycle.
- The operating cycle is how long
from when we buy the inventory
to when we collect the cash associated
with selling that inventory.
- Walmart, for example,
sells the inventory that it purchases
from Toro, or Procter & Gamble, or Ben & Jerry's ice cream
in an average of 42 days.
That's an average across all their product lines.
Some items sell faster than that, and some take longer.
But on average, 42 days.
- Since for Walmart, all sales are basically cash sales.
When you use a credit card at Walmart,
it's effectively cash to them.
Now you owe your credit card company.
Walmart gets their cash immediately.
They buy the inventory, hold the inventory for 42 days,
and then collect the cash immediately
from selling that inventory.
Let's take a look at Nike.
They hold their inventory, on average, for 92 days.
That's the length of time from when they purchased
the raw materials for the shoes and clothing,
to when that material is turned into athletic apparel
and sold to the retail outlets of the world
for you and me to buy, 92 days.
- And then Nike has to wait for their customers to pay them.
Now, keep in mind, Nike's typical customer
is not you and me,
that would be Foot Locker and Dick's Sporting Goods,
and a hundred other retail vendors who sell Nike products.
- And how long does Nike have to wait to collect the cash?
About 36 days on average.
Some customers pay sooner than that, and some pay later.
But on average, Nike waits 36 days from the sale
to the collection of cash from that sale.
So, Nike's operating cycle is 128 days.
The time from the purchase of raw materials
to produce the athletic apparel,
to the time they collect the cash from their customers.
128 days.
Over four months.
Nike has a long operating cycle.
- And why is this number important to know?
Because now I can start to manage it.
I can stay on top of my receivables,
the companies that owe me money,
to ensure that they pay in a timely fashion.
I could try to drive the time I wait
to collect the money owed me, down.
And I can measure the results of my efforts
by monitoring this number.
- I can also take efforts to manage my inventory better.
I can try to reduce the days that I hold inventory.
The results of these ratios provide direction
to what aspects of the business to manage.
And then the results of these ratios
tell me how effective my efforts were.
- So, where do we get these numbers
for Walmart and for Nike?
Which financial statements do I go to,
to find out how long a company holds inventory,
and how long a company has to wait
to collect cash from its customers?
- And here you go.
Those numbers aren't provided by the companies,
you have to compute them.
But as you're going to find out
in the next couple of modules,
if you know where to look,
those numbers are hiding in plain sight.
- With a little analysis of the financial statements
to identify relevant information,
and the computation of a couple of ratios
relating to the operating cycle,
you will soon know more about a company
than most of their employees do.
Now that is power.