Cash Flow in Business Planning and Management


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For businesses, cash flow plays a key role in determining the success or failure of its operations. However, cash flow management and planning is not easy, especially for those who are not effective in accounting applications. Nonetheless, it is impossible to succeed in business without a mastery of fundamental cash flow projections (Brigham & Ehrhardt, 2013). It is plausible to remember that it is possible for the business to be making a profit and, at the same time, operate under poor cash flow. The reality abounds when there is a lack of synchronization between the cycle of cash coming in and moving out of the business. Hence, it is critical for any person running a business, whether large or small, to understand the cycle and ensure that it is synchronized with relevant operations. The most important thing to understand is the role projections play, although they never have to be 100% accurate (Chen & Chen, 2012). Working through the cash flow in business planning and management is critical, and a factor that business people cannot escape.

The Cash Flow

The cash flow is among the most important concepts for effective planning and management of businesses. Within the world of business, like in other disciplines, concepts have various definitions as different scholars bring in their diverse views within the business practice. Cash flow is one such concept with diverse definitions within the business field. Financial management and accounting texts offer diverse definitions of period cash flow. One of the perspective in looking at the concept is to differentiate between diverse terms that are often confused with cash flow (Brigham & Ehrhardt, 2013). For example, cash flow is not the same as income revenue, credit sales, or profits. Regardless of the diversity of descriptions of the term, a working definition has been developed. The definition is the one that is commonly used in the texts on the concept of cash flow. The concept defines the net cash amount as well as equivalents to cash, flowing in and out of the business (Brigham & Ehrhardt, 2013). See figure 1 below for a pictorial representation of the concept.


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(Source: Brigham & Ehrhardt, 2013).

Cash flow is considered the lifeblood of the business. The reality is that it is the indicator of the health of the business. Essentially, it is being recognized that cash flow is the main concern for businesses, whether small, medium, or large-scale. Even the directors in the vast corporations are showing increased concern over the cash flow of the businesses they manage. As a result, cash flow modeling is a basic element in the financial operations of the company. Cash management is vital for the successful running of business, in whatever environment they operate, to allow for increased liquidity of the company (Kroes & Manikas, 2014). The impact of cash flow for the business is a reality because of the effect it has on the effective continued running of the business. Hence, it is necessary to monitor, protect, control, and influence the cash need of a company. The management should be aware of the fact that cash is not static or passive and has to move for the company to operate productively.

Cash flow can have a negative aspect or positive feature, which is a representative of the influence it has on the liquid assets of the business. Where the liquid assets are on the increase, the cash flow is considered positive as it becomes easy and possible for the business to pay debts, give returns to shareholders, reinvest, pay expenses, and ensure savings to address the future needs of the business. On the other hand, cash flow is negative in the case where there is a decrease in the liquid assets of the business. In fact, it is worth noting that the aspect of net income is not synonymous with the concept of net cash flow. The former indicates the accounts receivable together with other payments for which the business has not received payment (Kroes & Manikas, 2014). The assessment of the quality of the income of the business is performed using the cash flow and not the net income. It is the indication of the solvency status of the business as it indicates how liquid the business is.

Cash flow, from an accounting perspective, suggests the difference between the amount of cash the business has at the start of a particular period and what is available when the same period ends. Indeed, this suggests the difference between the opening and closing balances. If the former is less than the latter, there is evidence of positive cash flow, whereas the other way around suggests a negative flow. For the business, some of the ways by which the cash flow increase are the sales of goods, sale of assets, reduction in cost, increase in the price of selling goods, faster collections, lower payments, taking loans, or adding equity. However, the cash flow level does not essentially suggest a positive measure of how the business is performing. Definitely, high cash flow levels do not indicate high profitability for the business. Also, high-profit levels do not indicate positive or high level of cash flow (Simons, 2013). Basically, the business should seek to ensure positive cash flow while striving to remain profitable.

The Cash Flow Cycle

The cash flow cycle is among the factor considered in measuring the effectiveness of a business. The cycle indicates the rate at which the business is able to convert the level of cash it has into more cash for the effective running of the business. The cash flow cycle achieves this aspect through continued conversion of the available cash into account payable and inventory via accounts receivable and sales and to cash flow once again. It is a cycle that moves from initial cash flow and back to positive cash flow. In general, a company is in a better place when the number is low (Chen & Chen, 2012). However, it should be blend with various other measures, including return on assets and return on equity. The measure is used in the comparison of competition given the reality that those companies with lower cash flow cycle indicator are potentially the one with the most effective management.

The cash conversion cycle refers to the blend of a number of activity ratios that involve various measures in the running of the business. The metrics used include inventory turnover, accounts receivable, and accounts payable (Simons, 2013). Accounts inventory and receivable usually highlights the business short term assets, while account payable on the other hand indicates the liability. The balance sheet includes all the ratios indicating the general performance of the business. Hence, the ratios are an indication of the efficiency in the generation of cash through effective management of liabilities and short term assets. Where investors are making the decision to capitalize or continue investing in the business, the measure of efficiency is the most important consideration (Brigham & Ehrhardt, 2013). Essentially, the investor seeks to establish whether the management of the company will be able to convert the investment into more cash flow. Success in this aspect allows the company to attract more investment.

The cash conversion cycle (CCC) is a common concept that arises in the process of managing cash flow for any business. Also referred to as the “cash gap,” the term is used in reference to the time period (in days) necessary from the time of purchase of the inventory at the time when the company receives payment from selling the goods (Kroes & Manikas, 2014). With an increase in the sales made by a company, there is a need for greater levels of accounts receivable and inventory. Basically, financing is critical given the reality that the payables’ natural increase cannot be adequate to cater for the increase in need for cash. It is important to understand what is meant by “cash gap” going as far as providing illustrations to enhance the comprehension. Given the fact that most of the people, even those starting a business lack the knowledge of what is meant by the terms, use of case studies enhance the understanding (Muscettola, 2014). The descriptions are even more critical to establish the basis for lending even for small businesses.

How the Ratios Relate Business

The business operations of the company determine its performance in terms of the cash flow. For instance, selling the things that people are willing to pay for, there is faster cycling of cash through the company. The cycle becomes slower in the case where the management is not able to decide what sells fast (Simons, 2013). For instance, if inventory accumulates in the business operations, the firm may end up hoarding cash in good that might not be selling.

The situation is not good for the productivity of the company and does not encourage greater investment. Addressing the problem might suggest a situation where the company cuts the price to move and get rid of the goods, potentially by making a loss. Selling the goods fast at a loss might be at a loss for the company, but it allows for the held up cash to be released (Chen & Chen, 2012). It can allow for a comeback for the company or cause potential failure depending on its management.

The management of the company is the determining factor in how the ratios work for the business. The management is the basis for effective administration of the accounts receivable. In the event of poor management of the ratio, there is clear indication of the company’s failure to effectively collect payment. The reality is that the accounts receivable are loans that the company has given to the customers. Hence, there is a loss for the company in any delay by the customers in paying the loans. If the business has to wait for a long time to receive the money, it means that the cash is not available to invest in other profitable operations. By slowing down payment of accounts payable, on the other hand, means that the company will benefit as the cash can be invested elsewhere before it is paid to the suppliers (Simons, 2013). The general idea is that the management determines how well the ratios are managed to allow for effective cash flow cycle.

Cash Flow Statement

Management of finances is critical for the business to operate effectively and to source financing from lenders. In a business plan, it is critical to show evidence that one is planning for a business that will operate productively for a very long time without running out of cash. The lenders have to be convinced that the business has the potential to effectively manage its cash flow cycle (Simons, 2013). Such fundamental information is provided by the concept of cash flow statement. In fact, the tool plays the role of tracking the cash as it flows in and out of the business, showing cycles in payment or cyclic trends necessitating additional capital to support the running of the business. The information allows for planning and ensuring that the company has the cash for covering payments. When the business is commencing, the management requires adequate capital to start and continue running a successful business. The cash flow statement is the part of the business plan that the investors or funders are looking for (McKeever, 2016). Hence, the management will have to convince them that the business will have adequate capital flowing in and out of the company to remain afloat.

All the cash items coming in and going out of the business should be listed in the cash flow statement. For the next 12 years, it should be possible for an interested party to look at the statement and realize the potential of the business. Cash incoming and Cash outgoing should be the headings for the list, which include the figures of each item. The opening balance shows the position where the business is at the start of a fiscal period (Simons, 2013). For a startup, this is the initial capital, while it is the closing balance of the previous period for a business that is continuing. The total incoming cash is also stated, followed by the total outgoing cash. The closing balance is the cash at the end of the fiscal period being investigated. The balance between the two indicates the cash flow status of the business (McKeever, 2016). In a business that is starting, the business plan includes estimates of the incoming cash and the outgoing, but they should be realistic.

Cash Flow is About Timing

The management of the company should be effective in managing time to ensure effective cash flow management. Evidently, for the business, cash flow cycle is all about how well the business is able to allow cash to flow in an out of the business. Hence, forecasting is an important factor if the cycle has to be managed well and in a way that benefits the investors. The operating cycle of the business is also the basis for effective cash flow because it is the determining factor of what and how cash flows in and out of the business (Uwonda, Okello, & Okello, 2013). The cash flow cycle is based on a number of parts that are always moving, including buying and selling, the process of collecting and paying debts, and the operating costs including rent, salaries, and marketing. All the activities are about being good at timing the activities; for example, to ensure that there is undue cash held by the debtors or in unsold goods.

Timing is of the essence as it tells the difference between the inflow and outflow of cash in the business, given the fact that the cash flow cycle is the same across most companies. The amount of time between the cash flowing in and that flowing out of the business makes a lot of difference in the working of a business. Businesses have different experiences regarding the time period it takes for the cash to flow in and out. For instance, it is possible for a business to have a long cycle as a result of outstanding sales taking days with little cash remaining to cater for the expenses (Chen & Chen, 2012). The failure to have liquid cash can have tremendous impact on the business which can even result in failure when the company runs completely out of cash. The reality explains why it is critical for companies to have faster cash flow cycles to ensure that there is adequate cash to cater for the day to day running of the business. Also, the faster the customers pay for the goods or services, the more the cash the business has to cater for the operation of the business and to reinvest in the business.

Importance of Managing Cash Flow through Projection

A company should be able to operate with positive cash flow effectively. For the purpose of investment, negative cash flow can spell doom because cash flow is a critical factor in determining whether the business gets the funding. Seasoned creditors have an effective review process to determine which companies qualify for the loans and the one which does not, all of which has the basis in the cash flow cycle (Kroes & Manikas, 2014). For businesses, it is critical to find out and implement the strategies that will allow them to have adequate cash flowing in and out of the company. While businesses, especially the new ones, consider growth in sales as the main indicator of success, they get in shock when they realize that they lack the cash to operate effectively. Hence, it is critical, even for starters to ensure that they have adequate working capital to remain afloat for a long period of time. It is also the basis for obtaining initial and working capital from lenders.

Cash flow projections can be clearly provided to the investors with the use of basic spreadsheet applications. The cash flow projection provides a clear picture of when the cash is flowing into the business and how and when it is moving out. It also shows the balance that is left in the business. At the beginning of a period, the management can look at the cash balance, and the same is done at the end to establish the difference. Understanding these figures play an important role in planning and anticipating the operations of the business in the coming periods. It is also a source of information for the management to consider the possible challenges and pitfalls within the business’ cash flows in and out of the business (Uwonda, Okello, & Okello, 2013). It is an important tool in business planning as it indicates the performance of the business, both in the present and the future. The cash flow figures are critical for further investment in the business. For example, where the business is commencing, the projections are provided to source funding; for instance, in the form of loan.

During planning for the long-term or short-term finances for the business, cash flow forecasting is more imperative than planning for profits. While the difference between costs and sales revenue provides a clear picture of the working of the business, the profitability is not necessarily the indicator for the survival of the business into the future. Many businesses that fail do so because of the failure in the process of cash flow management than due to failure to make profits. The growth (survival) and investment potential of a business depends on the cash flow cycle (Uwonda, Okello, & Okello, 2013). If the company is not making adequate cash to balance with the cash that is moving out, the survival of the firm is greatly impacted. Therefore, this calls for the management to be effective and efficient in the management of the activities that have the potential to bring in more cash for the company. In this case, the company will have enough cash to operate successfully, generate more revenue, and survive into the future.

Objectives of Managing Cash Flow

There are various objectives that are critical for management of cash flow. One of the objectives is to engage in the activities that generate and accelerate cash flows into the business. For instance, where possible, sales should be capitalized on and be managed in such a way that they allow greater flow of cash into the business (Uwonda, Okello, & Okello, 2013). Another objective is based on the aspect of delaying the cash flowing out of the company until when they are due. For example, the management can delay payment to the suppliers until the agreed date instead of paying before the due time. The delay will allow the company to hold the cash longer and use it for more activities that will generate more cash for the business. Another objective is investment of the surplus cash to earn more profit for the company. Investing the cash instead of saving in the company’s account a sure way of earning more cash for the firm and increasing the cash flow (Muscettola, 2014). More cash can also be obtained through borrowing on those terms that are efficient and which will provide more liquid cash for the company without necessarily increasing the outflow of cash. The management should also strive to maintain cash level at the optimum, not deficient or in excess.

The Five Stages of Cash Flow Cycle

The recent collapse of Darrell Lea among other companies has led to an increase in the attention to the significant role played by cash flow. The event has led to more attention to the management of cash flow to allow for a business to remain afloat regardless of the challenges in the operating environment (Chen & Chen, 2012). Particularly, for the start-ups, lack of effective means of managing the cash flow cycle can lead to the collapse of the business as cash flow determines whether the business will continue successfully or will collapse. Hence, it is critical to understand the impact of the cash flow cycle on the business to ensure that the business has enough cash flowing in and out. The Commonwealth Bank reveals that each dollar invested has to go through the cycle before coming back to the investor with profitability. Successful businesses are those with a faster cycle (Kroes & Manikas, 2014). In this case, there are five stages that businesses, especially those starting, should understand in order to be effective in managing their cash flow cycle.


(Source: Kroes & Manikas, 2014).

Stage 1: Payment Received

This stage is familiar to most of those running the business. It is a stage that is expected by those beginning their business because they are expecting cash returns from what they are selling to the customers. However, cash should not be the isolated modes of payments in this case since the business should be open in using other form of payments, including direct deposit, e-commerce, PayPal, over the phone, checks, debit or credit cards among other payments platforms. The use of the various means of payment allows greater choice for the customers to use at their convenience, and hence greater cash inflow for the company (Uwonda, Okello, & Okello, 2013). Nonetheless, where the business provides the customers with the opportunity to buy on credit, this means that some cash will be delayed. The payment, even when using some of the modes, means that there will be a delay as the cash is being processed.

Stage 2: Manage the Cash

Once the cash is available to the company, it is critical to have in place effective strategies for its management. The cash comes into the business for use in some ways and not just to lie in the bank account. Management of liquidity differs from the status of profitability. Even when operating profitably, it is still possible for the company to run out of liquid cash. The surplus cash available to the business should be used in such a way that it works for the business based on the needs. While it is advisable to save the surplus to cater for the future needs of the business, it is even more beneficial to reinvest the cash such that it is capable of bringing in more cash (Uwonda, Okello, & Okello, 2013). However, this is for the cash remaining after the production costs are catered for; there are suppliers to pay or equipment needed for greater production. The cash should also be adequate to address the costs of operation to run a successful business.

Stage 3: Make the Payments

The cash that comes into the business, including from sales does not all belong to the business because of the payables. Indeed, this is where the payments to the suppliers and the staff are put into consideration. There are also other operating expenses that should be paid for using the cash. The payment should be done on the due date to allow for use in activities that have the potential to bring in more cash flow to the business (Yazdanfar & Öhman, 2014). It is also critical for the business to track the expenses to ensure that the company is not running out of cash flow. For example, if the expenses are greater than the incoming sales revenue, then the situation spells doom for the business. 

Stage 4: Finance the Purchases

It is critical in business planning for the management to prepare and plan for funding of the purchases (McKeever, 2016). It is critical to establish whether the company has the finances for doing this, especially where the payments are made in cash. However, in the event that the payments are made on credit, it means that planning has to be made in the following month, once the receivables have all been collected. The management should have in place the forecasting and budgeting tools showing the cash the business owes others and how much is owed to the business by others and the projected date for the payments. If there is adequate cash to finance the purchases, then it is even better because the business will be able to continue making more cash (Yazdanfar & Öhman, 2014). However, this can work for seasoned businesses and might not work for startups. Also, the company could consider an external source of funding to cater for this need.

Stage 5: Inventory Control

After receiving and making payments, the levels of inventory are another factor to be put into consideration. Management of the inventory is critical for the business to continue operating productively. The levels of stock should be adequate to cater for the needs of the customers, not so high that it exceeds the demand or too low not to meet the demands. Having more stocks that meet the demand is damaging to the business because it suggests that cash will be held up which cannot be reinvested or used to pay for the expenses (Yazdanfar & Öhman, 2014). It is critical to ensure that the excess stock is sold, even at a discounted price, to ensure that the cash is invested. Effective management systems should be in place to avoid the potential of holding up inventory. Also, having reliable suppliers is necessary for successful management of inventory.

The Calculation

Calculating the cash conversion cycle takes into consideration a number of items from a financial statement of the business. Therefore, COGS and revenue calculate the cycle of cash conversion usually in the income statement. From the time period for which the opening and closing balances are to be calculated, the inventory is the item that is considered. Accounts receivable at the start and conclusion of the period are also used, as well as the accounts payable. Another important factor used in the calculation is the days making up the period of consideration. In this case, duration of one year is represented by 365 days, while 90 days will stand for the quarter of an year. Balance sheets are the sources of the information for use in making the calculations (Muscettola, 2014). Under those premises, two balance sheets will be in operational, especially when a quarter of a year is under study. On the other hand, only a single balance sheet will be applied when a single year is under analysis, which covers the same quarter of the current year as well as the previous quarter of previous year.


The reason for these considerations is due to the fact that the income statements cover is a report of the activities that happened within the concerned period. On the other hand, balance sheets provide a simple snapshot of the status of the business during a particular instant. For activities such as accounts payable, the focus is on the average of the period of time being investigated (Yazdanfar & Öhman, 2014). Hence, for the calculation, there will be a need for accounts payable at the end of the time period as well as the start of the period. Hence, with the background, to calculate the cash conversation cycle uses the formula:


All the components have a relationship to the activities of the business over the time period being investigated.  DIO represents the Days Inventory Outstanding. The concept is used in reference to the number of days that it took the whole inventory to be cleared by selling (Muscettola, 2014). In this case, it is always to the advantage of the company when the figure presented is small.

DIO = Average inventory/daily COGS
Average Inventory = (opening inventory + closing inventory) /2

DSO represents the Days Sales Outstanding. The concept relates to the days required for successful collection of sales. It entails the collection of accounts receivable by the business. Although sales on cash-only suggest a DSO of zero, it is not always the case that all customers pay in cash (Muscettola, 2014). The customers are always taking advantage of the credit facilities that the firm offers. Just like DSO, the smaller the DIO, the better for the business.

DSO = Average AR/daily Revenue
Average AR = (opening AR + closing AR)/2

DPO is the Days Payable Outstanding. The concept entails the payments by the company of the bills or the accounts payable. Maximization of this is possible with the company holding on to cash for a long time, allowing for it to invest it before paying (Muscettola, 2014). Generally, it is better for the company to have longer DPO.

DPO = Average AP/Daily COGS
Average AP = (opening AP + closing AP) /2

It is important to note the pairing of the three, DIO, DSO, and DPO with the relevant terms, either COGS or revenue as used in the income statements. There is evidence of the pairing of AR with revenue and AP and inventory with COGS.

Example from a Case Study

It is critical to use the formula in real life to establish how it works in the business environment. In a business plan, it is critical to be able to compute the cash flow in order to make the image clear to the investors (Mathuva, 2015). The example below is for a retail company with its relevant numbers. Millions of dollars are represented in all the figures:

Item Financial year 2016 Financial year 2015
COGS 4,000 Not necessary
Revenue 10,000 Not necessary
inventory 1,200 2,500
AP 900 1000
AR 120 100
Average inventory (1,200 + 2,500) / 2 = 1,850
average AP (120 + 100) / 2 = 110
average AR (900 + 1000) / 2 = 1400


With the figures, it is possible to calculate the cash conversion cycle:

DIO = $1,850 / ($4,000/ 365 days) = 185 days
DSO = $110 / ($10,000 / 365 days) = 4 days
DPO = $1400 / ($4,000/ 365 days) = 140 days
CCC = 185 + 3.9 – 103.4 = 85.5 days

It is plausible to note that CCC as a stand-alone number does not mean a lot for the management of the company. Rather, the number is critical for tracking the performance over a period of time. It is critical for measuring the competitiveness of the company, especially when appealing to the competitors. Given the reality that the performance of the company is not a one off activity, it is critical to keep track of how it is performing over a period of time. Determining the CCC over a period of time indicates a worsening or improving performance of the company. For example, if the company, in the financial year 2015, there was 90 days regarding the CCC, then the 2016 figure of 85.5 days is evidence of improvement (Mathuva, 2015). Between fiscal year 2016 and the end of fiscal year 2015, the company appears to be doing well regarding cash flow.

While there is an evident improvement between the two financial years, any considerable changes in DSO, DIO, or DPO would call for more investigation, like going further back in the years to realize what might have caused such changes. The changes in CCC ought to be assessed over a number of fiscal periods to establish the nature of change and the factors surrounding it. Such an investigation is critical for the management of the company to plan for the future (McKeever, 2016). For the competitors of the company, it is critical for the CCC to be computed for the same period of time. For instance, for the financial year 2016, the CCC or the main competitor of the company was 100.9 days. The evidence suggests that the company in the case study is doing better compared to the competitor. It also means that the management of the company is more effective in moving inventory, as indicated in the lower DIO. Also, with the lower DSO, it is evident that the company is doing better at collecting its debts (Mathuva, 2015). With higher DPO, it means that the company is able to keep the money a bit longer than the competitor.

However, it is critical to note that the CCC is not the only measure for use in evaluating the management or the company itself. However, despite all the indicated measures, the efficiency of a management should also be measured through return on equity as well as return on assets. For more explanation, some assumptions might be brought forward to indicate that there is an online retailer who is the firm’s competitor. Therefore, during the same duration, the CCC would be at -31.2 days for the online competitor. The idea, in this case, is that the company fails in paying the suppliers long after there is payment for the supplied goods (Mathuva, 2015). Hence, the company does not have to keep a lot of its inventory and is able to hold the cash for a long time. In terms of CCC, the online retailers perform better which indicates the reason why CCC should not be the sole matrix for evaluating performance of a business.

The Basic “No Growth” Case

To introduce the concept of CCC in a more understandable form, it is critical to start with an explanation of the “no growth” situation. The initial case is based on the assumption that there are constant levels of inventory. Simply, it begins with an assumption that the expenses are not depreciating or amortizing (Mathuva, 2015). Another assumption is that the selling of the goods or services is all on credit. Thus, the following equation is the basis for defining cash flow per month:

NCFn = Salesn-k – APn  – OCn             (1)

            NCF n = for month n, this is the net monthly cash flow

Sales n-k = the amount of sales for the n-k month, with k being the months from when the selling is done to when the cash is collected.

APn = for month n, the accounts payable

OCn = these are the other costs, including the taxes, operational costs as evident for month n.

Under certain conditions, the first equation provides the net cash flow for any month. Therefore, to find the cumulative net cash flow, it becomes necessary to include the present cash flow for the month and the ones incurred in the past months (Mathuva, 2015). The equation (2) below is used in calculating the cumulative net cash flow.

CNCFn = NCFn + CNCFn-1                      (2)

            CNCFn = through month n, this is the cumulative net cash flow.

Given the reality that there should be continued persistence of the working capital, it is critical to have an understanding of the two concepts, the cumulative and periodic net cash flow. An example can be used in developing scenarios to demonstrate the cash flow of a company over a period of time.

Indeed, approximately $200,000 might be assumed as the sales for the company in a given month. Hence, all customers making the sales total bought the goods on credit. The cost of goods sold is 68% of the overall sales. The payables’ terms are net 30, and the collection of the accounts payable is done in a quarter of a year (90 days). Hence, the CCC is two months (90 – 30 days) between the disbursement of the AP and the real collection of the AR. The reality is the leading contributor to the deficit in cash flow. It is presumed that there are 24% of sales in taxes and operating costs in the month. Therefore, the company is shown to earn $1- .68 – .24 = $0.08 for each unit of sales. Hence, it indicates that the net profit margin for the company would stand at 8%. Therefore, if the value of sales remains constant, assuming that no growth is experienced besides the original $200,000, then there will be a negative cumulative cash flow experienced by the company. The scenario will go on for 25 months that the company will be in operation. The reality will reflect the CCC which is as a result of AP being due 60 days prior to the collection of AR (Yazdanfar & Öhman, 2014). Although after fourth month of operations when AR begins to be collected, a point at which there is potential for the cash flows to become positive, a long time period will be necessary to cater for the deficit in net flows.

It is critical for those starting their businesses to understand the cash gap and avoid being caught up in the behavior of spending a lot with the expectation of disposable revenue. Failure to mind the gap is a definite way of making sure the business fails to succeed and survive into the future. Financing will be made if the management of the business has adequate understanding of the cash flow gap and the expectations of remaining afloat in the future, lest the investment is all lost in businesses that cannot survive into the future. For the amounts of cash flow revealed by a small business, the loan can be considered a line of credit. However, although the example is useful in explaining the concept of CCC, it is a scenario that is not practical in the world of business (Yazdanfar & Öhman, 2014). The main objective of those beginning a business is to witness its growth. It should also be noted that the interest costs that relate to cash gap financing diminishes the availability of the cash flowing in and out of the business. Hence, it is critical to find a source of financing that is not high in interest to increase cash flow. 

Financing Sales Growth

All businesses are in operation with the objective of making profits and enabling sales growth to ensure that there is adequate flow of cash. Hence, financing is done by various institutions based on the potential of the business to achieve sales growth. The example below is a scenario of financing sales growth in business. A rate of increase in sales of 12% is assumed with the objective of incorporating the cost of financing. To calculate the rate, .12/12 = .01 every month. The increase in sales means that the company is spending more in terms of cost of production. It is possible that the AP is not growing at the same rate, which means that it is not capable of covering the increase in the production cost. It is in such a scenario that the business has to consider borrowing from external sources (Yazdanfar & Öhman, 2014). Obtaining the finances from the external sources is meant to expand the cash flow for the company.

While borrowing is a critical part of the business operations, it comes with an additional channel for spending by the business, which is the interest. It also means that the company is operating under a new strain in terms of the operations’ cash flow. With all the other assumptions remaining the same, assume that the interest cost per annum is 8.5% (.085/12 = .0071 each month). 

The formula for the net cash flow per month is thus:

NCFn = Salesn-k – APn  – IEn – OCn                                      (3)

IEn = per month after-tax interest expense, calculated as

IEn = (CNCFn-1) (interest rate per month) (1 – t)        (4)

Thus, the marginal tax rate for the company is t. The adjustment is a reflection of the deduction in tax emanating from the expense in interest cost. The cost is expressed in an after-tax terms. For convenience, this operates under the assumption that every month there is a tax saving emanating from the expense on interest. In fact, this is regardless of the reality that the aspect occurs on a quarterly basis.

Given the reality that the net income flow of the company is affected by the external borrowing, it is critical to consider the rate of inflow (from the borrowed finances) against the outflow (the expense in terms of interest on the borrowed finances). In the case of the company used as the example, the management has to get the external finances at the annual rate of 8.5%. At this rate, it is possible to support the increasing production emanating from the increasing sales by the company (Yazdanfar & Öhman, 2014). The case study is indicative of the impact on cumulative and monthly net cash flows as a result of the growth in the sales volume of the business. Since the company has to get the finances to continue operating with sufficient capital, it is critical to have an understanding of the effect, and how the percentages in the principal amount borrowed and the interests are likely to impact on the business’ liquidity.

Because of the gap between the collected receivables and due payables, the gap in cash flow together with the extra cost from the interest on the external finance, the company is likely to suffer a cash drain. Hence, it might take time for the company to begin having positive cash flow. For example, while there is growth in the sales of the company, it might take as long as four months to get a positive cash flow (Yazdanfar & Öhman, 2014). However, the accumulated deficit might affect the company for as long as 31 months. Indeed, this is different from the accumulated deficit in the “no growth” example. Therefore, to ensure that companies do not meet their demise from the starvation in cash, it is critical for the lenders to consider the growth effects and finance the business appropriately (Brigham & Ehrhardt, 2013). The examples can be useful to the lenders in highlighting the changes in the effects on the business. Generally, the changes in the cost of goods sold, the sales growth rate, and other costs, as well as the CCC are critical when planning for a business.


The importance of cash flow in a business cannot be ignored for a business that is working to succeed. It is one of the most important factors determining the relevance of the business regardless of the size. Thus, proper management of the cash flowing in and out of the company is critical for success. The cash flow life cycle should be well managed to ensure that the company is operating efficiently by ensuring that the cash in and out of the business is adequate.  The importance of cash flow to the management is showing the wellbeing of the business and allowing for added operating capital from investor and lenders, who use the information in assessing the creditworthiness of the business. Worth noting is that cash flow and profitability of the business are two concept that are equally important. Hence, the management should have in place effective tools for recording, computation, and management of cash flow. In essence, cash flow is the basis for effective planning of any business.



Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory & practice. Cengage Learning.

Chen, H. J., & Chen, S. J. (2012). Investment-cash flow sensitivity cannot be a good measure of financial constraints: Evidence from the time series. Journal of Financial Economics, 103(2), 393-410.

Kroes, J. R., & Manikas, A. S. (2014). Cash flow management and manufacturing firm financial performance: A longitudinal perspective. International Journal of Production Economics, 148, 37-50.

Mathuva, D. (2015). The Influence of working capital management components on corporate profitability.

McKeever, M. (2016). How to write a business plan. Nolo.

Muscettola, M. (2014). Cash Conversion Cycle and Firm’s Profitability: An Empirical Analysis on a Sample of 4,226 Manufacturing SMEs of Italy. International Journal of Business and Management, 9(5), 25.

Simons, R. (2013). Performance Measurement and Control Systems for Implementing Strategy Text and Cases: Pearson New International Edition. Pearson Higher Ed.

Uwonda, G., Okello, N., & Okello, N. G. (2013). Cash flow management utilization by small medium enterprises (SMEs) in northern Uganda. Merit Research Journal of Accounting, Auditing, Economics and Finance, 1(5), 67-80.

Yazdanfar, D., & Öhman, P. (2014). The impact of cash conversion cycle on firm profitability: An empirical study based on Swedish data. International Journal of Managerial Finance, 10(4), 442-452.

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