Managing Cash Flow: Understanding Your Business’s Operating Cycle

Knowing the inflows and outflows of money are critical to business success

Knowing the inflows and outflows of money are critical to business success

By James A. Anderson

If cash flow is the lifeblood of your small business, think of your company’s operating cycle as its metabolism. That’s because your operating cycle not only tracks how much cash you need to fuel basic duties to provide a service or make goods, but also how soon your company gets nourishment in the form of payments from customers or vendors.

With an understanding of your operating cycle, you know how much working capital you need month-by-month as well as the time it takes to recoup the money you spend to keep your business running. Dallas, Texas-based small business consultant Andrea Travillian says small business owners need time and good data to figure out their business cycles. “It is best to start any business with a conservative spending cycle until patterns are learned,” she says.

Follow these steps and the example of the hypothetical Jane’s All-Star Plumbers to learn more about your business’s operating cycle. While you’ll want to track your business’s income and expenses for several months to determine the length of your operating cycle, this exercise can help you get an idea of how much working capital you may need.

Step One: Calculate your monthly expenses such as rent, utilities, and labor. This is what you’ll be spending money on regardless of how much money your business makes in a given month.

Step Two: Estimate how long it takes to bring in clients or close deals. This is a time in which you may not have money coming in yet.

Step Three: Determine how long it takes to complete a service or provide a product. You may have to spend money to complete the work before you get paid for the service.

Step Four: Determine how long it takes to get paid. Do you get paid immediately or do you send clients an invoice? Estimate how long it takes for the money to be deposited into your bank account once the client pays.

Step Five: Come up with a contingency plan for late payments. You might rely on savings or a line of credit to manage cash flow when your receivables are late.

If your business is a startup, Travillian says you can get a good estimate of how your operating cycle measures up by contacting a local office of the Small Business Administration or an accountant who has experience with companies in the same line of business. Then, over time, you can gain a better understanding of your cash flow by keeping close tabs on receipts, receivables, inventories, and expenditures over the course of a year.

James Anderson is an English professor for the City University of New York as well as a writer with over 25 years of experience in the fields of finance and business. 

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