The Cash Flow Cycle
Your company engages
in various activities in the production of revenue, continuously
generating and spending cash. These activities affect its cash position
at any point.
The cash flow
cycle, in its simplest form, revolves around the company’s
trading cycle. The process involves purchasing inventory, converting
that inventory to cash or accounts receivable via sales, collecting
those accounts receivable, and paying suppliers who extended trade
Purchasing inventory and carrying accounts receivable
are uses of cash. If the company doesn’t have a sufficient
cash reserve, these assets must be funded from other sources.
The primary source is credit granted by suppliers, known as
All things being
equal, the faster you collect your accounts receivable, and the
slower you pay your suppliers, the better your cash flow. Unfortunately,
the level of trade credit is rarely sufficient to cover both the
company's trading cycle and your normal operating expenses. As a
result, additional financing is needed.
One source is
bank financing through a line
of credit. Sales growth usually requires an expansion of accounts
receivable and inventory levels. Often new fixed assets are needed
as well. Both create the need for additional long-term
will be in the form of long-term bank loans, commercial
mortgages, or leases.
However financed, the level and timing of repayment impacts your
need for cash at particular points in time.
Claims on Cash
There are four
areas which have primary claim upon your cash flow. These are:
Repayment - Meeting short-term and long-term debt obligations, plus
operating expenses when they come due.
Growth - As your company grows, new assets, both current and fixed,
will be required to support that growth. Cash flow must either
provide sufficient earnings retention to support growth, or
at least provide for a level of borrowing power, allowing
new assets to be financed.
Contingencies - As a reserve for unanticipated events.
Return - Provide shareholders with a sufficient return on their
The Cash Budget