Question

Explain in two pages (maximum) the link between a firm cash flows and its product cycles.

Answer 1

There are five different stages involved in the life cycle of a product. They are:

1.Research and development (R&D)

2. Introduction

3. Growth

4. Maturity (or saturation)

5. Decline.

The first stage is the R&D stage in which an organization invests on research in areas of innovation and new product development. During this stage an organization only makes investments to fund research into new ideas and products. No income is generated during this stage and the product is being developed and is work in progress. Thus during this stage there is only cash outflow and no cash inflows.

The second stage is the introduction stage. In this stage the actual product has been developed and is launched in the market. During this stage as the product has just been launched in the market the company spends a huge amount on promotions, advertisements and marketing. This is done to establish a connect with the customers. Sales remain low during this stage. Hence as spending is more than the revenues the net cash flow remains negative during this stage.

The third stage is that of growth. In this stage sales start growing, depending on the fact whether the product is successful or not. The product captures higher market share and hence the quantum of revenues increases. During this stage a company starts earning positive net cash flows as the amount of its cash inflows exceeds the amount of its cash outflows.

The fourth stage is the stage of maturity. In this stage sales growth starts tapering as the market has saturated and hence there is no further room for growth. This stage will have the longest duration compared to the duration of other stages in the life cycle of a product. During this stage cash flow reaches a peak and then starts declining.

The last stage is the decline stage. In this stage the revenues and sales begin to decline. The revenue will continue falling while the cash outflow may remain constant. Firms do not increase their spending on advertisements and marketing in this stage.

Thus product life cycle and cash flow display similar behavioral patterns and the cash flow cycle is dependent on the product life cycle.