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What Is The 'Cash Flow Cycle'?

The Cash Flow Cycle describes how the cash Flows in and out of business. Receivables are promises of payment you've received from others. Debt is a promise you make to pay someone at a later date. To bring in more cash it's better to speed up collections and reduce the extension of credits.

Josh Kaufman Explains The 'Cash Flow Cycle'

Money flows through a business in predictable ways. If you understand how revenue, expenses, receivables, and credit work, you can ensure that you continue to have enough purchasing power on hand to continue operation and maximize your available options.

The Cash Flow Cycle describes how cash Flows through a business. Think of your business’s bank account like a bathtub. If you want the water in the bathtub to rise, you add more water and keep it from leaking out via the drain. The more water that flows in and the less that flows out, the higher the level of water in the tub. Revenues and expenses work the same way.

Receivables are promises of payment you’ve accepted from others. Receivables are attractive, because they feel like a sale—someone has promised to give you money, which is great. There’s a catch, however: receivables don’t translate into cash until the promise is fulfilled. IOUs are not cash—the more quickly that promise is translated into payment, the better your cash flow. Many a business has closed with millions of dollars of “sales” on the books.

Debt is a promise you make to pay someone at a later date. Debt is attractive because you can benefit from a purchase now while holding onto your cash until later. The later you pay, the more cash you have at your disposal. Debt can be useful, but there’s also a catch: debts typically cost additional money in the form of interest. Very often, you’ll also have to pay back a portion of your debt over time, which is called “debt service,” which you can treat as another type of expense. If you can’t cover your debt service, you’re in trouble.

Maximizing your cash tackles the issue directly: bring in more revenue and cut costs. Increasing your product margins, making more sales, and spending less of what you bring in will always improve your cash flow.

Deferring or negotiating slower re-payment with your creditors can also help alleviate a cash crunch. If you have a supplier, vendor, or partner that is willing to let you pay later in exchange for receiving materials or capabilities now, that allows you to keep more cash in your bank account now. You must watch this carefully: debts can easily get out of hand if you don’t keep track of how much you owe and when it’s due.

Used properly, however, paying creditors later can be quite useful, particularly for marketing expenses. Borrowing $1 to make $10 is a good trade; it’s even better if you’re able to do that for months before the first marketing bill comes due.

To bring cash in more quickly, it’s best to speed up collections and reduce the extension of credit. The faster you get paid, the better your cash flow situation. Ideally, try to get paid immediately, even before buying raw materials and delivering value.

It’s common in many industries to extend credit to customers, but that doesn’t mean you have to as well. Always remember that you’re a business, not a bank (unless your business involves Loans) — collect any outstanding payments as quickly as possible.

If necessary, you can increase your purchasing power by taking on additional debt or opening lines of credit. It’s best to avoid using debt or lines of credit if you don't absolutely need to, but increasing available credit certainly increases your purchasing power. Think of these accounts as back-up funding sources—they’re there for emergencies only.

The more Purchasing Power you have, the more Resilient your business is and the better your ability to handle the unexpected.

Questions About The 'Cash Flow Cycle'

• Is it possible to strengthen your cash flow by collecting receivables earlier, paying creditors later, or reducing your overhead?
• Can you increase your available purchasing power by opening a line of credit or other expandable option for use if unanticipated events occur?

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"All truth is found in the cash account."

Charlie Bahr, management consultant

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