Main menu

Production Cycle

Production Cycle – a period during which inventories are being turned by the company into finished goods. To calculate this indicator the analyst should multiply the average inventories by the number of days in the year and divide the result by the cost of goods sold. Another computation option for this indicator is dividing 360 days by the inventory turnover. The ratio measures the efficiency of the production process.

For the company the decrease of the production cycle is desirable. Such dynamics means that the company is decreasing the amount of time needed for turning its average inventories into finished goods. Short operation cycle allows to decrease the share of fixed expenses in each dollar of manufactured goods and provided services. The production cycle is different for different industries and business segments. For example, the production cycle for the windows manufacturing enterprise would be much shorter, than for the automobile manufacturers. For more precise estimation of the company’s financial condition it is reasonable to compare the company’s production cycle with main competitors.

Resolving the problems with the production cycle exceeding the normative range:

In case the value of this indicator is too high comparing to main competitors, it is necessary to conduct some actions to decrease it. To do this the company's management can inspect the production process and make a record of everything that leads to the time loss. Working with weak spots will increase the indicator's value.

Formula(s):

Production Cycle = (360 × Average Inventories) ÷ Cost of Goods Sold

Should be taken into account that the inventories amount may vary, and it happens to be higher or lower than usual at the end of the year. Thus, if the analyst has access to the company's daily or monthly report, it is reasonable to use the data it contains. Below are the formulas for the average inventories calculation options:

Average Inventories (the preferable calculation method) = Sum of the inventory amounts at the end of each working day ÷ Number of working days

Average Inventories (if only monthly data available) = Sum of the inventory amounts at the end of each month ÷ Number of months

Average Inventories (if only annual data available) = (Inventory amount at the beginning of the year + Inventory amount at the end of the year) ÷ 2

Company A

Balance Sheet

$

as of

12/31/YEAR1

$

as of

12/31/YEAR2

$

as of

12/31/YEAR3

Assets
II. CURRENT ASSETS
Inventories 94 89 87
TOTAL 201 198 201
Balance 311 312 375

 

Company A

Income Statement

$

YEAR2

$

YEAR3

Net sales 1278 1250
Cost of goods sold 984 975

Production Cycle (Year 2) = (360 × (89 ÷ 2 + 94 ÷ 2)) ÷ 984 = 33,48

Production Cycle (Year 3) = (360 × (87 ÷ 2 + 89 ÷ 2)) ÷ 975 = 32,49

The production cycle decline over the analyzed period witnesses the production efficiency growth. In year 2 the process of converting the inventories into finished goods required 33,48 days, while in year 3 this number was 32,49 days. Further improvement of this process might require the assets structure and volume optimization. This would allow to free up some additional funds.

Conclusion:

The faster the company is able to turn inventories into finished goods, the more efficient its production process is. Declining the production cycle is a strategic goal for the enterprise since this shortens the amount of time the inventories spend in a warehouse with no use.