Life-Cycle of Financing

February 19, 2022

2 minutes read

Life-cycle finance is based on the assumption that people prefer relatively steady spending from year to year and detest rapid fluctuations in consumption, especially on the negative. This hypothesis is known as consumption smoothing in economics.
As a result, in terms of economic life-cycle saving and investment, personal finance is primarily concerned with shifting consumption across time and across scenarios. This necessitates the movement of financial and insurance assets through time and across circumstances.

While financial managers at large corporations use sophisticated analyses to determine the optimal mix of external funds from different sources, some general rules of thumb apply when financing a firm’s operations and growth.

Firms should match their assets to their financing

A firm should try to finance short-term assets—such as inventory—with short-term financing—such as commercial paper. Similarly, they should finance long-term assets—such as a new factory—with long-term financing—such as bonds or common stock.

Firms should follow a general life-cycle model of financing

The life-cycle model of financing states that a firm’s financing decisions should match its stage in the life-cycle.

The graphic below shows the types of financing typical within each stage of the life-cycle: start-up, growth, and maturity.

Revenue Growth and Life-Cycle Financing

The graph below shows three life-cycle stages: Start-up, Growth, and Maturity.

Notice that during the Start-up phase, revenues are low, but increasing. Revenue continues to increase during the Growth phase; Maturity occurs once revenues begin to peak and level off.

How Does The Cash Flow Pattern Of A Business Develop Across Its Life Cycle?

when a business first starts out, the cash outflow of the business will be very high because you’re just the business is just starting up, expenses will exceed revenue, and you’ll be you won’t have credit terms, so to speak, with your suppliers because you’ll be a new business so that you won’t get cash discounts. And you’ll be outlaying cash to either build your inventory to sell your product.

If the business grows, you’ll hopefully cash received your accounts receivable will build as you generate more revenue. But again, even as you’re growing, it’ll be you’ll start to see a stable a more stable pattern of cash. Because even though the company might be more profitable, though, your expenses might still be high because you’re still in the process of bringing on employees, you’ll have payroll costs, you’ll have vendor costs, and also, you know, inventory costs.

So, as the company matures a little bit, you’ll be looking for that stabilization until you release, until you come to a place where the company has–revenue has outpaced expenses, you have a good handle on your expenses, both fixed and variable, and your revenues are far exceeding your expenses so much so that you have more free cash flow to reinvest into the business, to expand the business, or even to pay out to your shareholders.

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