Operating and Investment Cycles

Let’s take the example of a greengrocer, who is ‘‘cashing up’’ one evening. What
does he find? First, he sees how much he spent in cash at the wholesale market in the morning and then the cash proceeds from fruit and vegetable sales during the day. If we assume that the greengrocer sold all the produce he bought in the morning at a mark-up, the balance of receipts and payments for the day will deliver a cash surplus.

 
Unfortunately, things are usually more complicated in practice. Rarely is all
the produce bought in the morning sold by the evening, especially in the case of a manufacturing business. A company processes raw materials as part of an operating cycle, the length of which varies tremendously, from a day in the newspaper sector to 7 years in the cognac sector. There is thus a time lag between purchases of raw materials and the sale of the corresponding finished goods.
And this time lag is not the only complicating factor. It is unusual for
companies to buy and sell in cash. Usually, their suppliers grant them extended
payment periods, and they in turn grant their customers extended payment periods. The money received during the day does not necessarily come from sales made on the same day.

 
As a result of customer credit,supplier credit and the time it takes to manufacture and sell products or services, the operating cycle of each and every company spans a certain period, leading to timing differences between operating outflows and the corresponding operating inflows.

 
Each business has its own operating cycle of a certain length that, from a cash
flow standpoint, may lead to positive or negative cash flows at different times.
Operating outflows and inflows from different cycles are analysed by period, e.g., by month or by year. The balance of these flows is called operating cash flow. Operating cash flow reflects the cash flows generated by operations during a given period.

 
In concrete terms, operating cash flow represents the cash flow generated by
the company’s day-to-day operations. Returning to our initial example of an
individual looking at his bank statement, it represents the difference between the receipts and normal outgoings, such as on food, electricity and car maintenance costs.

 
Naturally, unless there is a major timing difference caused by some unusual
circumstances (start-up period of a business, very strong growth, very strong
seasonal fluctuations), the balance of operating receipts and payments should be positive.

 
Readers with accounting knowledge will note that operating cash flow is
independent of any accounting policies, which makes sense since it relates only
to cash flows. More specifically:

1)neither the company’s depreciation and provisioning policy;

2)nor its inventory valuation method;

nor the techniques used to defer costs over several periods have any impact on the figure.

 
However, the concept is affected by decisions about how to classify payments
between investment and operating outlays.

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