Evaluate trends in the length of a company’s operating cycle

- A company's operating cycle is the length of time from when the company buys its inventory until when the company collects the cash associated with selling that inventory. Computationally, the length of the operating cycle is the sum of the number of days sales in inventory and the average collection period. Here are the length of operating cycle numbers for Walmart, Nike and Chipotle for the three years, 2018, 2019, and 2020. By the way, Chipotle is a US fast food restaurant chain specializing in freshly made Mexican food. First, we aren't surprised to observe that the length of the Chipotle operating cycle is much less than the other two companies. Because Chipotle is a fast food company, we expect them to have a quick operating cycle. In this case, the average time from purchase of inventory to the collection of cash from selling that inventory is about 10 days. It is interesting to note the five day number of days sales in inventory for Chipotle. This is shorter than the seven day number of days sales in inventory for McDonald's that we saw in an earlier module. Now we shouldn't read too much into this, but perhaps this is an indication of the relatively higher mix of fresh ingredients in the Chipotle menu. Now let's compare the number of days sales in inventory number for Walmart, a retail company, with Nike, a manufacturing company. I say manufacturing company in quotation marks because Nike outsources the actual manufacturing to partners around the world. Sometimes the finished goods are shipped directly from the outsourcing partners to the retail stores buying the Nike products, but more commonly, Nike takes delivery of the finished goods inventory, stores it, and ships it to the retail stores. This inventory handling process takes two and a half times as long at Nike, about 100 days, as it does at Walmart, about 40 days. Next, compare the average collection periods across the three companies. We see that the period for both Walmart and Chipotle is quite short, just four or five days. We are not surprised because the vast majority of Walmart and Chipotle customers are retail customers, such as you and me, who either pay cash immediately or who pay with a credit card. Now retailers such as Walmart and Chipotle typically collect the cash from credit card purchases within a day or two. There's a little delay between when your credit card purchase is authorized at the cash register and when the actual payment is processed and sent to the retailer. In contrast, Nike collects its money from retailers, such as Foot Locker and Walmart, and those receivables are handled under normal business credit arrangements, about 30 days. Now speaking of Nike, take a look at the upward spike in 2019 in number of days sales in inventory from 95 days in 2018 to 127 days in 2019. I'm sure that this large increase caused some concern among the logistics managers at Nike. Fortunately, the number was back down to 102 days the next year. Next let's look at the three year trend in the length of the operating cycle for Walmart. The operating cycle length is 46.4 days in 2018 down to 45.5 days in 2019. And then down, again, to 43.3 days in 2020. This steady reduction is due to reductions in the number of days sales in inventory. This trend makes it clear that Walmart is relentlessly working to remove slack and delay in its distribution network and in maximizing the speed of turnover of inventory in its stores. Now a three day reduction in Walmart's number of days sales in inventory might not seem like much to you and me, but remember, Walmart holds about $45 billion in inventory. This three day, or 7% reduction, means a reduction of about $3 billion in Walmart's inventory compared to what it would've been without the improved efficiency in managing inventory. That, ladies and gentlemen, is working capital management, keeping the investment in working capital items, such as inventory, as low as possible to reduce the need for external financing.