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 credit.

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 trade credit.

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 financing.

This financing 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 Flow

There are four areas which have primary claim upon your cash flow. These are:

1. Repayment - Meeting short-term and long-term debt obligations, plus operating expenses when they come due.
   
   

2. 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.
   
   

3. Contingencies -  As a reserve for unanticipated events.
   
   

4. Return - Provide shareholders with a sufficient return on their investment.

The Cash Budget

Neither the publisher nor distributor is engaged in the rendering of legal, accounting or professional services. All articles, calculators and other content is provided for general information only. We suggest that you consult your appropriate professional advisors with regard to your individual situation.

Copyright Greer Group 2002, All rights reserved.
Your Source for the Best Content On The Net.