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Maximize Cash Flow: Cash Cycle

FastTrac, Kauffman Foundation

The cash cycle can be used to monitor and improve internal cash flow. The cash cycle tells the number of days it takes for your business's cash to be invested into your products or services and received back again from sales to customers.

Consider a business with a very short cash cycle—a restaurant. In the restaurant business, inventory (food) is sold quickly and customers generally pay their bills immediately. This set-up creates a very healthy, and short, cash cycle. The restaurateur also gets to hold onto cash before paying employees and many vendors. Compare this arrangement to the long cash cycle of a pharmaceutical company, which must have significant funds available just to research and develop new products to be created, tested, approved, and then sold. The longer the cash is out-of-pocket, the harder it is to pay your bills and show a profit.

The cash cycle is measured by comparing four primary components: Accounts Receivable, Inventory, Accounts Payable, and Payroll. The first two componentstend to lengthen the cash cycle because your cash is out-of-pocket, invested in inventory and sales. The second two components often shorten the cash cycle as cash sits in your pocket while you take some time to pay your bills and employees. In order to measure the components of the cash cycle, you will calculate four ratios: Days Receivable, Days Inventory, Days Payable, and Days Payroll Accrual. These ratios make up the Cash Cycle equation:

Cash Cycle Equation

+ Days Receivable

+ Days Inventory

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