Operating Cycle
The cycle through which the activities of the trading business revolve is called Operating Cycle. The stage of the operating cycle begins with the purchase of goods. the sale of the goods in arrears, and the process ends with the collection of cash from the debtor.
Although the income assessment of a trading / merchandising company is similar to that of a service company, but its operating cycle is slightly different. The management cycle of a trading / merchandising organization is longer than the management cycle of a service organization.
The management cycle of the service and product business organization:-
The cycle shows that the operating cycle starts with cash investment in both service firms and trading firms and similarly ends with cash receipts. Due to the nature of the two organizations being different from each other, differences can be observed in some stages of the cycle. Two additional steps are observed in the case of trading institutions. a) Purchase of stock b) Storage of stock.
In service companies, goods are not bought and sold but income is generated by providing services. Therefore, a service organization doesn’t have purchasing system or inventory storing system. On the other side, trading organization, goods purchase and storage are two necessary steps. The operating cycle of a trading company is a bit longer than a service company.
Steps of Operating Cycle
1) Investing Cash: The first step in the operating cycle of a trading business starts with investing cash in the business. Because cash is needed to start daily activities.
2) Purchasing Inventory: The second step in the operating cycle is purchasing products.
3) Storing Inventory: At this stage purchased goods are stored. The activities from purchase of goods to sale are considered as part of this stage.
4) Selling Inventory: The fourth step of the operating cycle is to sell the stored inventory. The sale can be either for cash or on credit. This is where the operating cycle phase ends if there is a cash sale. In case of credit sale, two more steps have to be passed.
5) Accounts Receivable: Accounts receivable or trade debtors are created from the sale of goods on credit.
6) Collecting Cash: The last step in the operational cycle is to collect cash from the debtor. If the note receivable is received from the debtor, the cash is collected by clearing it from the bank or by paying the notes receivable at the end of the term.
More Resources
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