- Okay, one of my favorite things in accounting is
to take these two ratio, day sales and inventory
and average collection period, and add them together.
Together, they tell me a company's operating cycle.
Again, an operating cycle is how long from when we buy
the inventory till we collect the cash
associated with selling that inventory.
We just went through how these numbers are computed.
Let's look at a couple of companies
that we're all familiar with,
and see if those numbers make sense,
given what we know about the companies.
Let's start with McDonald's.
How long does their food, the stuff we eat,
sit with the company before it's sold to us.
Well, it turns out we can calculate that.
Remember, we first compute our inventory turnover measure
by dividing cost of sales by our average inventory.
For McDonald's, their inventory turnover's 57.
In other words, McDonald's turns their inventory
over 57 times a year.
Well, how many days is that?
Well, we simply divide 57 into 365 days to get the answer.
It turns out McDonald's sales
and inventory is about six days.
Now, before you think that's too long,
it's important to point out
that McDonald's cost of sales includes
both the food and the packaging.
Their inventory includes both the food
and the package that the food comes in.
So the food and the packaging are with McDonald's
for an average of just over six days.
Now, what about their average collection period?
Well, since we all pay in cash
or with a credit card when we buy McDonald's,
and credit card sale is a simply a cash sale
from a McDonald's point of view,
their average collection period (tongue clicks), zero.
So McDonald's operating cycle is about 6 1/2 days,
and when you consider that McDonald's may have
up to 60 days to pay for the food
and the packaging that they purchase,
well McDonald's is sitting in a pretty good place.
Buy inventory, sell it in six days,
and pay for it in 60 days.
What does McDonald's get to do
with all that money for the extra 54 days?
(chuckles)
Whatever they want.
Now, let's talk about motorcycles.
Let's talk about Harley-Davidson.
How long does it take for Harley
to construct the bike and sell it?
Well, it turns out we can calculate that.
On average, it's about 60 days to get the parts for a bike,
put that bike together, and then sell it to the dealer.
You can see those computations right here.
We compute inventory turnover
and divide that number into 365 days.
The result?
About 60 days.
Now, how long does the dealer have to pay for that?
Well, we can calculate that as well,
and it turns out, it's about 23 days.
And you can see those computations here.
So Harley's operating cycle is 83 days,
60 days to build the bike and get it to the dealer,
and 23 days to wait for the dealer to pay.
Since cash is the lifeblood of a business,
cash is the oil that keeps the business machine running,
it makes sense to track how long it takes
for cash to cycle through the business.
I can take day sales and inventory
and average collection period and figure out how long
from when a company buys their inventory
till they collect the cash for that inventory.
That is called the operating cycle.