Question

Explain how the cash flow cycle works.

Answer 1

The cash flow cycle shows how the cash flows in and out of a business. The cash flow cycle consists of three distinct parts. In the first part the flow determines the period of time that a business takes to sell its inventory. This part of the cash flow cycle makes use of days inventory outstanding calculation. In the second stage current sales are considered and the amount of time it takes to collect cash from the sales is computed. In this part days sales outstanding metric is used for calculation purposes. In the last stage the cycle computes the amount owed by the business to its vendors and suppliers for inventory purchased by it. It also involves determining when the business will pay off its dues. In this stage of the cycle the metric of days payable outstanding is used for calculation purposes.

Thus cash flow cycle = days inventory outstanding + days sales outstanding – days payable outstanding.

In other words we can say that the cash flow cycle, as computed using the above steps and formula, measures the number of days it takes for a business to receive cash from a buyer from its initial cash outlay that the business had made for inventory.