The business 101 cycle

In one paragraph

Money goes round a business in a loop: owners invest, assets generate income, income becomes profit, profit becomes cash, cash returns to the owners or goes round again. The faster it turns, the higher the return.

Owners put money in. Assets — bought with it, or with new loan finance — are used to generate income. Profit is the return on those assets. Cash is generated from the business activity, and flows back to the owners as drawings or repayments, or is reinvested.

Where the loop drains

Each stage has gains and drains, and they are specific.

Profit drains: unchecked overhead. Profit gains: sales growth, margin growth.

Cash drains: slow collection of debtors, rising stock or work in progress, loan repayments, tax payments, paying suppliers faster than you are paid. Cash gains: faster collection, less stock, slower payment of suppliers.

Owner drains: drawings and personal loan repayments taken out faster than the loop can replace them.

Accelerating the cycle raises return on investment without a single extra sale. Most owners try to grow the loop instead of speeding it up.

How to actually use it

• Time one full turn: from spending money on stock or wages to the cash from that work landing in the bank. That number is your cycle, and shortening it is free money.
• Check the owner drain honestly. Drawings taken faster than profit is generated is the most common cause of a profitable business with no money in it.

Where it breaks down

• Simplifies a real balance sheet considerably. It is a way of seeing the flow, not a substitute for management accounts.

If you are being examined on it

Excellent for explaining working capital and the difference between profit and cash.

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