How does the cash flow pattern of a business or company develop across its lifecycle?
Let's explore the dynamics of cash flow in this video!
Life is full of S-curves!
In nature, as well as business.
You might have come across a term called the product life cycle, which is often used to
describe the rise and fall of a technology.
That is one example of an S-curve.
If you think about data storage and data transfer, then several technology S-curves come to mind.
Floppy disks became ubiquitous during the 1980s and 1990s, with incremental improvements
in terms of floppy disk sizes and storage capacity.
The advent of recordable CDs was a jump to a new technology curve,
with floppy disk usage declining, and CDs becoming the dominant technology.
Next to CDs, USB sticks or memory sticks got introduced and gained great popularity.
Since then, data storage and data transfer have largely moved to the cloud.
You can roughly distinguish four or five phases in a technology lifecycle,
and apply the same concept to a business.
Start off as embryonic or emerging, then go through growth, maturity,
and ultimately aging and decline.
Two big and tough to answer strategic questions are: where are we now on the S-curve for our
product or service, and when do we jump to the next curve?
Easy to predict with hindsight, but hard to decide when you are in the middle of it, and
possibly making very good money with an existing technology!
What do cash flow patterns look like when you move along the S-curve?
Let's look at Cash From Operating Activities, Cash From Investing Activities,
and Cash From Financing Activities in each of the phases.
In the embryonic or emerging phase, CFOA outflow is very high due to expenses being higher
than revenue, a lack of leverage with suppliers to get payment terms, and inventory build.
CFIA is a significant outflow, as the company builds capacity to start production.
CFFA is a large inflow, as the company is raising capital (debt or equity).
In the growth phase, CFOA at some point nears or slightly exceeds zero.
There is a growing receivable balance when revenue starts getting generated, so even
though the company may be profitable, that might not translate yet to positive CFOA.
CFIA outflow continues to be high, as the company is expanding and scaling up.
CFFA is a large inflow, as the company goes through another round of raising capital.
In maturity, a successful company has a high CFOA cash inflow: the incoming cash receipts
from customers far exceed the outgoing payments to suppliers, employees and the tax authorities.
This provides lots of financial flexibility for various types of cash outflow:
CapEx (in CFIA), acquisitions (in CFIA),
dividends (in CFFA), share buybacks (in CFFA), and debt repayments (in CFFA).
For an aging or declining company, CFOA is drying up more and more as the product or
service becomes a low margin commodity, not a lot of reinvestment is needed to keep the
business going (CFIA), and the company tries to keep paying steady dividends to shareholders
(CFFA) for as long as it can.
Hope this helps your understanding of cash flow patterns at various stages
of a business lifecycle.
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