The Cash Cycle in Motion: Cash Balance

Living Without Food or Oxygen

For your business, profit is like food: you can survive for a while without it. Cash is like oxygen: you need it right now to stay alive. In order to manage your cash balance, you must understand the drivers of your cash flow. That requires an understanding of the cash cycle:

Cash Cycle

The Components of the Cash Cycle

In previous lessons, we put the components of the cash cycle in motion:

  • Purchasing and inventory
  • Expenses and accounts payable, and
  • Sales, shipments, and accounts receivable

In this lesson, you’ll see how changes in growth rates and management policies impact your cash balance over time. The depth and duration of cash deficits – something we call The Valley of Broken Dreams – will tell you the amount and term of the external financing a given growth scenario requires. That’s a handy thing to know as you formulate and execute your financing strategy.


Interdependencies Make Business Decisions Hard

You have to spend money to make money. If you want to increase your sales rate, you will probably need to accelerate your purchase of inventory. If your cash cycle is positive – that is, there’s a delay between the time you pay for your inventory and the time you collect sales proceeds from customers – growth is going to require cash. How much? By when? For how long? Those are questions that are tough to intuit, even for the most experienced businessperson.

A visual model like the one we’ve been using in this course is a good place to start to get a better understanding of your cash cycle and the dynamics of your cash balance is different possible futures.

Dynamic Model of Cash Flow

Dynamic Model of Cash Flow

Ultimately, it will help you develop useful rules of thumb to help guide your decisions in real time. Eventually, using these kinds of dynamic models will make your reading of traditional financial statements more productive.

Models Are Toys. Play with Them.

I strongly encourage you to play with the cash model. Seeing the connections between variables and watching the effects of changing assumptions is a powerful way to learn. Run comparisons. Ask questions. I’ve been studying cash flows for 30 years, and I can still say I learned a lot by creating and playing with this model. I hope you will, too.

Lesson tags: cash flow