Businesses of all types are organized around three fundamental cycles. In my last post, I talked about the operating cycle. Now I want to move on to the final level: the entity cycle.
In recent posts, I’ve covered the first two cycles, the operations and assets cycles, which most business owners are familiar with to some extent. The third cycle unfortunately gets overlooked by many small business owners because it doesn’t impact their day-to-day operations, but it’s critical that you understand what’s going on in this third cycle so you can make the best decisions about the overall health and direction of your business.
If you look at your financial statements at the statement of cash flows, you’ll see three cash flow levels from operations, investing, and financing. Using the terms “investing” and “financing” here can get a little tricky, because these words get used to describe so many different things. Instead, I refer to them as the asset cycle and the entity cycle.
The third cycle covers the lifespan of your business as an entity. It covers the company’s formation, how it grows through time, and how the company ends. If you are successful, you will hopefully see a positive return at the end of the cycle. For instance, by selling your company to another purchaser, or perhaps you plan to keep the business within your family, but even in this case, you still want to see your company grow.
When you put equity into the business, you are working in the entity cycle. The equity that stays and grows within your company is moving in this entity cycle. When you take out equity (this could be at exit or before) you are moving in this entity cycle.
The entity cycle is the longest of the three. A well-run business will outlive its long-term assets, like vehicles or equipment, cycling through these multiple times.
This is not just a concept that only applies to big businesses. It’s important to recognize that every business–including your business–also works this way. If you bring in other investors, they will think about their investment along this cycle, and you should too.
In summary, once you understand the differences between these three cycles and how they work together, you will be in a much better position to make the right decisions for your business and get back more from all that you have put into it.