 Hello and welcome to the session in which you would look at the operating and cash cycle. This topic is covered in a corporate finance course, the CPA exam. This topic deals with the short term financing of the company. How are we going to finance ourselves? It's very important that you understand how to compute the operating cycle, how to compute the cash cycle. Why? Because you could see this on your exam or you could see this on the CPA exam. Therefore, if you are a CPA candidate, I strongly suggest you check out my website, farhatlectures.com. I don't replace your CPA review course. You can keep it. Your CPA review course is your best friend. However, I can be a useful addition to that CPA review course. I can add 10 to 15 points by explaining the material differently. By doing so, I can help you understand your CPA review course. By doing so, you will do better on the CPA exam. And here's my offer to you. Simply put, are you willing to risk $30 to find out whether I can help you succeed at 10 to 15 points on your CPA exam? I think it's a fair risk, $30 for a lifetime investment, not bad to try it out. And if not for anything, take a look at my website to find out how well or not well your university doing on the CPA exam. I do have resources for other college courses and CPA sections as well. If you haven't connected with me on LinkedIn, please do so. And take a look at my LinkedIn recommendation. Please like my YouTube, share them with others, connect with me on Instagram, Facebook, Twitter, and please connect with me on Reddit. So operating and cash cycle deals with the short-term financing of the company. In other words, we need money to operate the business on a short-term basis. Pay our payable, pay our employees, manage our suppliers, so on and so forth. So we want to properly manage the timing of cash. We want to know how long it's taken us to receive the cash and when do we have to pay the cash. Therefore, we need to understand what is our operating cycle, what is our cash cycle. Therefore, we can manage those payments and inflow of cash properly. So to illustrate this, we're going to go through a typical activity for a company. What do they do first? Manufacturing or non-manufacturing? The first thing you do is you buy. You buy the merchandise. That's fine. What do you do after you buy the merchandise? Well, eventually you have to pay for the money. You hope to sell it before, but let's assume you can. First, you're going to have to pay for the inventory. And this should make sense. The time period from the time you purchased the inventory until the time you sell it, guess what? This is where you have an accounts payable. We call this period accounts payable period. For the sake of this illustration, we're going to assume it took you 30 days. Simply put this as zero. And after 30 days, you paid your bill. And that's typically the case for most payables. Now, you purchased this inventory. What did you purchase it for? You purchased it to sell it. At some point, you are going to sell your inventory. And let's assume it's going to take you an additional 30 days to sell this inventory. Okay? Then eventually, after you sell it, we're going to assume you're selling it on credit. Then you're going to have to wait to get paid. Eventually you would receive the cash. And we're going to assume it took you 45 days to receive that cash. Now, from the time you purchased the inventory until the time you sold it, we call this the inventory period from the time you bought it and the time you sold it. This is inventory. This is the stuff that you had at your store. And notice that's 60 days for the purpose of our illustration. From the time you sold the inventory until the time you received the cash, we call this, guess what? You want to guess? The account receivable period. This is how long you waited. And we're going to, we said this is 45 days. Well, guess what? From the time you started until the time you received the money, 60 plus 45 is 105. We call this 105 the operating cycle. So the operating cycle equal to the inventory period plus the account receivable period together, they give you the operating cycle. Now you remember at some point you paid cash and at some point you received cash. From the time you paid the cash and until the time you received the cash, who wants to guess what we're going to be calling this period? You guessed it, the cash cycle. So the cash cycle is from the time you paid the cash until the time you received the cash. And that's 30 days plus 45 days, that's 75 days. One way to compute this, to get to the 75 days, if you take the operating cycle 105 and deduct from it 30 days, which is the account period cycle, you'll get to the cash cycle. This is the cash cycle. See this is how you compute the cash cycle. You go with the operating cycle and from the operating cycle you deduct the AP period and that's going to give you the cash cycle. Now what is the goal of the company? The goal of the company is to do what? The goal of any company is to extend this AP period, extend this as much as possible and reduce this as much as possible. As you do so, let's assume we can extend our AP by 15 days, therefore now it's 45 days and we could reduce the overall operating cycle or let's assume we could reduce the waiting period down by 10 days. So we're going to be down to 95. Now notice the cash cycle, if my math is right, is only 50 days. So let's take a look at what typical questions you could see on the CPA exam when it comes to those examples. A company has an inventory period of 24.8 days. It means their inventory sits in their store on average almost 25, 24.8. Their accounts payable period 32.7. It means after they buy something, on average it takes around 33 days to pay it and their account receivable is almost 30 days, 29.6. You could be asked something like what is the operating cycle for this business and what's the cash cycle? So you could see a multiple choice. I doubt that they will give you a simulation and if they do, come on, bring it on. This is easy, right? So what is the operating cycle? The operating cycle is the whole thing. The operating cycle is the whole thing. It's the accounts payable plus the, well, not the whole thing. The accounts payable period, the accounts payable period plus the inventory period, plus the inventory period. Those two are the operating cycle. So the operating cycle is the 24.8 plus 29.6, which is the whole thing. This is what I meant by saying the whole thing. So it's 54.4 days from the time we buy something until the time we receive the money. What is the cash cycle? How long does it take from the time we pay until the time we receive the money? All we have to do is to take the operating cycle, 54.4 and deduct from it the accounts payable period, 32.7 and our cash cycle is 21.7. So you could see something like this on the exam day, maybe a multiple choice, but again, those are easy, easy multiple choice questions once you learn the material. And I would say, I'm going to venture and say most, most questions on the BEC section, I know some of you may not like this to hear this are easy. If you have a basic understanding, they only cover kind of the, they scratch the surface. So have a good understanding and you should be in good, you should be in good shape. Another way they can ask you about this, this is where you could include maybe assimilation or document review, which I doubt, but you have to be comfortable with this. They might give you a bunch of data like inventory, beginning inventory, ending inventory, account receivable, beginning and ending and accounts payable, beginning and ending. And they might give you sales on credit and they might give you cost of goods sold and they might ask you, you know, can you compute the operating cycle and the cash cycle for this company? Now, what do you have to do here? Well, here you have to learn or you have to know, obviously for the exam and I covered this totally in a separate section is how to compute inventory turnover, how to compute account receivable turnover, okay, how to compute payable turnovers. Those are ratios that you have to be comfortable with. I'm going to assume, you know them for this purpose. So we're going to illustrate them, but don't worry, I do have them in my course. I cover ratios in the tails because you need the ratios for the BEC. You may see the ratios and far and you may see the ratios definitely in audit when you do analytical procedures. Therefore, when I explain ratios, I explain ratios in the tails, but not in this session. This session is specifically for the operating and the cash cycle. So how do we compute this? Well, we can compute the inventory turnover. You have to know this. You have to know how to compute this. You're going to take cost of goods sold divided by the average inventory. The average inventory is beginning plus ending divided by two. Now, be careful on the exam day. They may tell you, they may tell you explicitly use the ending. It could be some algorithmic thing with the CPA exam. So be careful. If they don't tell you, then you would use the average because every time you divide by a balance sheet account, remember the balance sheet account is a point in time. Therefore, you'll take point one plus point two, which is the beginning plus the ending divided by two when you're using the balance sheet account. Because it's the balance sheet is a period of time, one point in time, not period. I'm sorry, one point in time. Therefore, we'll take cost of goods sold divided by inventory turnover. This company turn over their inventory five times. Now, to find out how many days it sits under shelves, what's the inventory period? We'll take 365, which is how many days in a year divided by 5.5. Now, in your textbook, you might see it as 360, just use 365 unless you are told otherwise. Then, so your inventory sits for 73 days. Now, we have to find out after we sell the inventory, how long does it take to collect the money? Something we have called an account receivable turnover. In the formula, sales on credit divided by the average inventory. So sales on credit divided by the average inventory, the average inventory. And it's 25 times. It means we buy, I'm sorry, we sell something. We receive the money, sell, receive, sell, receive 25 times, which is pretty good. It's approximately around 15 days. Typically, this ratio is 12 times, which is if you take 365 divided by 12, gives you approximately 30 days. So this company collect your money every two weeks. Now, the last thing we have to compute is the payable turnover, which is cost of goods sold divided by the average payable. And this should be 48,000, not 4,800. And payable is eight times. It means we pay our payable eight times a year. We buy something, we pay it, we buy something, we pay it on average. It takes us 45.6 days. Now, can we compute the operating cycle and the cash cycle? Sure we can. What is the operating cycle? It's the inventory period plus the receivable period. That's the operating cycle. And what's the cash cycle? Take this 87.6 and deduct from it the amount of time we pay for. We pay for the money. How long does it take us to pay for the money? And this is basically what you would expect to see on the exam day. Be comfortable. Those are easy points. At the end of this recording, I'm going to invite you again, farhatlectures.com. You are risking $30 to find out whether I can help you or not for the exam. I do have examples for you, extra exercises. Keep your CPA review course. I cannot replace it, but I can make you a stronger candidate with my material. Good luck, study hard, and stay safe.