The operating cycle of a merchandising company is the continuous series of transactions through which a business generates revenue and collects cash from customers. Unlike service-based firms, merchandising companies rely on the purchase and resale of physical inventory, making this cycle central to their operations.
The cycle is exemplified by companies like Lowe’s, a major home improvement retailer, which manages hundreds of inventory items to achieve success. Efficient execution of the operating cycle ensures competitive pricing and quick inventory turnover, critical for profitability.
The cycle begins with acquiring inventory for resale, recorded initially as an asset on the balance sheet. This step involves sourcing goods from suppliers, often on credit, creating accounts payable.
Next, the company sells the inventory to customers, frequently on account (credit terms), generating accounts receivable. Sales trigger revenue recognition and shift inventory costs to the income statement as cost of goods sold.
The cycle concludes with collecting cash from customers, converting accounts receivable into liquid assets. This cash is then reinvested into new inventory purchases, perpetuating the cycle.
Revenue is recognized when earned—typically at the point of sale—once the company fulfills its obligations and costs are known or estimable. This principle ensures accurate income statement reporting and impacts related financial elements like accounts receivable and cash flows.
Inventory is a highly liquid asset, sold within days or weeks, and is listed near the top of the balance sheet below accounts receivable. Its management is pivotal, as it transitions from an asset to an expense (cost of goods sold) during the cycle.