A company’s operating cycle is the number of days, on average, between the acquisition (or production) of inventory and the eventual sale of that inventory.
A company’s operating cycle is the sum of two metrics: days sales in inventory and days sales outstanding.
Days sales in inventory (DSI) indicates the average number of days to sell inventory. DSI is generally calculated by dividing the average inventory (sum of beginning and ending inventory divided by 2) by costs of goods sold and multiplying the result by the number of days in the period.
Days Sales in Inventory (DSI) = (Average Inventory / Cost of Goods Sold) x Number of Days in Period
Days sales outstanding (DSO) indicates the average number of days to collect payment from customers. DSO is generally calculated by dividing average accounts receivable (sum of beginning and ending accounts receivable divided by 2) by sales and multiplying the result by the number of days in the period.
Days Sales Outstanding (DSO) = (Average Accounts Receivable / Sales) x Number of Days in Period
Consider the following scenario. For the year 2023, a company has average accounts receivable of $500,000, average inventory of $350,000, sales of $5 million, and cost of goods sold of $3.75 million. To find the company’s operating cycle, we first find the DSI and the DSO.
The DSI is: ($350,000 / $3,750,000) x 365 ≈ 34 days
The DSO is: ($500,000 / $5,000,000) x 365 ≈ 37 days
The company’s operating cycle is 34 days + 37 days = 71 days