What is Cash Flow?

Cash flow is crucial for business survival, as even profitable companies can face financial challenges.

Revenue is generated when invoicing customers, but it doesn't guarantee immediate cash availability.

Profit, the remaining amount after subtracting expenses from revenue, is essential, but consistent profitability is necessary.

Cash flow, the actual money movement in and out of the business, is vital for managing expenses, purchasing inventory, and paying suppliers. Efficient cash flow management is key to preventing potential financial crises.

3 Key Elements of Cash Flow

• Accounts receivable refers to the funds customers owe your company for goods or services received but not yet paid for, contributing to cash inflow.
• Accounts payable represents the money a company owes its suppliers for provided goods and services, resulting in cash outflow.
• Inventory. encompasses raw materials and finished goods purchased from suppliers, subsequently sold to customers to generate revenue. The credit-based transactions involving inventory lead to the creation of accounts payable when purchased and accounts receivable when sold.

Cash Conversion Cycle

The cash conversion cycle gauges how swiftly a company transforms its available cash into inventory and then back into cash. Understanding the cycle's duration reveals the number of days the company's cash is tied up and unavailable for business use.

A shorter cash conversion cycle is preferable, indicating faster cash movement through the business. Quick inventory turnover, achieved through accelerated sales, reduces the average days inventory, but caution is advised against over-ordering or prolonged holding.

Efficient accounts receivable collection leads to a lower average days receivable, ensuring quicker access to cash.

Longer average days payable suggests supplier support in financing the business, it's important to maintain a balanced approach without exerting undue pressure on suppliers.

Calculate Your Conversion Cycle

Average days Inventory + Average days receivable - Average days payable = Cash conversion cycle

What does a positive cash conversion cycle mean?

A positive number means that your daily operations are tying up cash. You may need to get extra financing to support the business and be able to pay your suppliers on time.

What does a negative cash conversion cycle mean?

A negative number means your day-to-day operations are moving cash quickly through the business and you will not have any problem paying supplier invoices. The greater the negative number, the easier it is to pay suppliers and meet your financial obligations.