Foundations of New Venture Finance 257The Cash Flow Cycle. The cash flow cycle and its importance to the profitability of
the firm are illustrated in Figure 7.1.
The top portion of the figure shows the production cycle from material ordering to
finished goods inventory. It also shows the cash cycle from payment for raw materials
through the collection of receivables. The bottom half of Figure 7.1 illustrates the cor-
responding sources and uses of cash and the formula for calculating the length of the
cash cycle.
Segment 1 represents the time period of accounts payable for raw material. The gapÀ- Days in accounts payable =
- Days in raw materials inventory =
- Days in work-in-process inventory =
- Days in finished goods inventory =
- Days in accounts receivable =
Average accounts payable
Cost of goods sold – Labor
Average raw materials inventory
Cost of raw materials
Average WIP inventory
Cost of goods sold
Average finished goods inventory
Cost of goods sold
Average accounts receivable
Salesx 365 daysx 365 daysx 365 daysx 365 daysx 365 daysShort-term cash cycle = 2 + 3 + 4 + 5 – 1
b. Short-term cash cycleRaw
materials
inventoryWork-in-
process
inventoryFinished
goods
inventoryAccounts
receivableOrder
materialsa. Operations cycle
Production cycle
Cash cycle1 2 3 4 5¿¿¿ ¿ ¿ ¿½½½¾¾ ¾½ ¾½ ¾½ ¾ÀÀÀ À½
½¾
¾FIGURE 7.1 The Cash Flow Cycle