It is a fact that financial resources are essential to carry out any type of activity, right? Bringing this logic to the business scenario, the lack of turnover, unforeseen expenses, increased inputs, receivables delays, shutdowns without planning, among others, can compromise the company’s ability to execute its projects.
In view of this, it is essential that leaders master some strategic operational knowledge that helps to control the management of resources, such as the differences between the Economic, Financial and Operational Cycle.
Roughly speaking, these tools are used to measure the time in which corporate activities are carried out and to facilitate managerial financial control. The economic cycle is related to the sales journey, the operating cycle involves the entire production chain and the financial cycle deals with the company’s cash movements.
If you want to know the main financial processes of a business, we recommend reading this material here.
Now, to better understand the concepts and differences between the Economic, Operational and Financial Cycle, keep following this post. We separate the main information that your company’s managers need to ensure an efficient financial analysis. Good reading!
What is financial management?
THE financial management it is the set of measures and procedures that manage the monetary resources of a company. Valuations, analyzes, decisions, maintenance, everything connected with the financial assets of a business are controlled by it.
To this end, it covers activities such as:
- financial planning;
- cash flow control;
- operational payments and transactions;
- projections for future periods.
Through these practices, managers are able to monitor financial transactions more appropriately and ensure more assertive and efficient decision-making.
Understanding the differences between the Economic, Operational and Financial Cycle is an excellent way to optimize financial management. Later on we will explore its particularities in detail.
What is the importance of financial management?
To have efficient financial management is essential for the survival of the business in the Marketplace. This is because it is through it that the leaders identify the strengths and weaknesses, advantages and disadvantages, opportunities and financial threats of the business.
In other words, what is wrong or inefficient can be corrected and what is appropriate can be maintained or improved. In this way, the available resources are used more intelligently and the company’s profitability is enhanced, optimizing its competitiveness. It assesses the quality of the organization’s financial decisions, with a view to preserving results general.
The need to structure this management is evident. But it is worth noting that the quality and efficiency of its operations will only be significant if managers to master some financial tools and auxiliary analytical strategies.
An example of this is to understand the differences between the Economic, Operational and Financial Cycle and to know how to calculate them. And that’s what we’re going to cover next.
What is Economic Cycle?
Before exploring the differences between the Economic, Operational and Financial Cycle, let us know the individual particularities of each cycle, starting with the Economical one.
In a nutshell, the Economic Cycle (CE) analyzes a company’s sales journey. That is, the period in which a product or merchandise is in business, from its acquisition to the effective sale.
Since maintaining a stock generates costs for the organization, whether due to the demand for the use of physical space, technical maintenance and cleaning, expenses with lighting or even for stopped merchandise, which prevents the turning of strategic resources, its management must be done with care and criteria.
It is precisely to facilitate this control process that the calculation of the economic cycle is carried out. For this, managers must use the following formula:
Economic Cycle = Average Stock Term (SME)
The Average Storage Term is calculated by:
SME = (Average stock / Cost of goods sold) / 360
As its name suggests, Average Inventory (EM) is the average time of a product in stock. It is worth noting that the deadline of receipt does not count in the accounting for that interval. The Cost of Merchandise Sold (CMV), on the other hand, is the amount incurred to produce or store such product until it is sold.
Let’s see an example? Consider that your company has an EM of 10,000 pieces and a CMV of £ 5.
CE = SME = (10,000 / 5) / 360 = 5.55
The Economic Cycle or Average Term of Storage of your company is approximately 6 days.
What is the Operational Cycle?
To help you understand the differences between the Economic, Operational and Financial Cycle, we will now explain what Operational Cycle (CO) is.
CO is the cycle that deals with all business operations and, therefore, it is related to the other two cycles mentioned in this post.
Its analysis includes steps such as the purchase of raw materials, calculation of production costs, storage, sales process, payments to suppliers, sale and receipt, inventory, and so on. That is, it starts with the purchase of the goods (Economic Cycle) and ends with the receipt of the sale (Financial Cycle).
To calculate it, managers must follow the formula:
Operating Cycle = EC + Average Accounts Receivable (PMCR)
Let’s see an example? Consider that your company has an Average Accounts Receivable Term equal to 60 days. Therefore,
CO = 6 + 60 = 66
The company’s Operational Cycle is 66 days.
It is worth noting that in cases of organizations that operate only with cash sales, the differences between the Economic and Operational Cycles are null, since the PMCR is equal to zero.
What is the Financial Cycle?
Having understood the EC and the CO, we will explore the Financial Cycle (CF). This cycle is also called the Cash Cycle, because analyzes the movement of capital, from payment to suppliers to receiving customers. That is, its analysis begins at the moment of acquisition of the raw material and ends when the receipt for the sale occurs.
Its results directly influence the management of the working capital, which is basically the amount needed to finance the day-to-day activities of the business. This is possible because the CF allows managers to predict how much the company will have in cash at the end of the month, ensuring the condition of structuring preventive and / or corrective measures.
In other words, the greater the company’s bargaining power with suppliers, the shorter the financial cycle. To calculate the CF, the following formula is used:
Financial Cycle = CO – Average Payment to Suppliers (PMPF)
Let’s see an example? Imagine that your company has given a period of 30 days to settle the receipt of production inputs and is depending on the payment of customers to honor this commitment.
CF = 66 – 30 = 36
The company’s Financial Cycle is 36 days.
If there is any delay or default, the company enters into a situation of real debt to suppliers, right? With the CF, it is possible that the due date for receipts and payments or the number of installments offered in installment sales are controlled to ensure an appropriate circulation of funds.
That is, the longer the payment term to suppliers and the shorter the payment period from customers, the more money you will have in the company’s cash. With this, the greater the chances of keeping the business financially healthy.
What are the differences between the Economic, Operational and Financial Cycle?
Now that each of the cycles has been explained individually, it is easier to compare the differences between the Economic, Operational and Financial Cycle.
Of fundamental importance for financial control and business management, the three types of analysis are used to measure the time over which an organization’s processes are developed.
With the Economic Cycle, all inventory management can be done with more precision and assertiveness. And so, the waste and the loss can be mitigated. With the Financial Cycle, the cash flow gains security. This is because the management of accounts payable and receivable is done in a rigorous and continuous manner.
In addition, emergency correction operations can be structured so that measures are taken prior to the occurrence of defaults or delays, thus preserving the financial health from the company.
Already With the Operational Cycle, the entire production chain process can be measured. That is, it validates the time invested in each operation to ensure that the business is being managed to its full potential. After all, if all steps are within a safe time frame, the productivity and profitability are inevitable consequences.
The importance of analyzing the Cycles
The differences between the Economic, Operational and Financial Cycle are clear, however its relationship to the financial health of the organization is evident. All data about the resources that enter and leave the company pass through the three cycles and in this way, managers gain an arsenal of data that will guide them strategically.
We can conclude that, although the volume of day-to-day activities keeps the focus of entrepreneurs and their managers on customer service and sales, it is essential that they take the time to analyze these three cycles.
Each of them is essential for the good development of the business, that’s why every manager must know his applications. Mastering the differences between the Economic, Operational and Financial Cycle can take the business to a new level of market competitiveness.
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