Listen to this articleLike blood, cash supports all the operational activities and keeps the company alive and going. Like blood, the cash needs to flow smoothly.
The importance of tracking cash flow and closely monitoring cash flow metrics can be deduced from the importance of cash itself.
You can call cash the lifeblood of the business, and for two reasons. One, like blood, cash supports all the operational activities and keeps the company alive and going. Secondly, like blood, the cash needs to flow smoothly.
An obstruction in the cash flow will negatively hamper the business’s profitability and performance. Moreover, not monitoring the cash flow means the business is not analyzing the financial health of the company. In addition, it will let the fraudulent activities bloom and flourish.
To prevent this from happening, businesses establish and monitor cash flow metrics and KPIs. Before we explore what the cash flow metrics are, let us understand what operating cash flow is.
Cash Flow and Operating Cash Flow
We hear these two terms often – cash flow and operating cash flow. There are two important questions I wish to answer here.
- Are cash flow and operating cash flow different terminologies or synonymous?
- If cash flow and operating cash flow are separate things, what are the similarities and differences between the two?
Cash flow is the study of cash through the business, whether into it or out, for calculating income, expenses, and profit. Now, cash flow is a very general term, while operating cash flow and free cash flow are contextual.
Operating Cash Flow Vs. Free Cash Flow
Operating cash flow and free cash flow are contextual cash flows calculated for analyzing and keeping track of a company’s performance. These are two critical metrics.
Operating cash flow is the cash flow through the normal operational activities of the business. It is an indicator of whether the operational activities generate enough income to keep the company alive and going.
Free cash flow, on the other hand, is a measure of income the company makes by putting aside the payment for interest and capital expenditures.
Here’s How to Measure Cash Flow Performance
The performance of business cash flow is measured by comparing the current face value of the KPIs with the historical benchmarks and also with the industry standards. However, that needs a knowledge of the crucial cash flow metrics and KPIs to monitor.
Let us now explore the top business metrics & cash flow trackers a business needs to evaluate and improve its performance.
What are the Cash Flow Metrics and KPIs?
Cash flow metrics are quantifiable measures utilized to track the cash flow of the business.
KPIs is short for key performance indicators, which are some identifiers the business establishes to analyze and evaluate its performance and financial health.
The cash flow metrics help the business understand its current financial position and make strategic decisions. Moreover, the businesses use the KPIs and cash flow metrics to compare themselves with historical data and other businesses. In a time of financial crisis, it is the selected KPIs that help the business react spontaneously and make fast decisions.
Top Cash Flow Metrics and KPIs For Cash Flow Management
We’ve already discussed the two important metrics used for cash flow management – free cash flow and operating cash flow. Let us look at some important metrics one must have a good grasp on for evaluating a statement of cash flow.
1. Operating Cash Flow Margin
The operating cash flow margin is a measure of the cash generated from operating activities in comparison to the sales revenue in a time period. The positive score reflects the company is profitable.
2. Days Sales Outstanding (DSO)
Also known as – Debtor days
Daily sales outstanding reflect the average number of days the consumers take to pay for the goods and services. Ideally, a company hopes for a low DSO, which means the buyers are making the payments in less time.
3. Days Payable Outstanding (DPO)
Also known as – Creditor days
Here, the company is the consumer and takes some days to pay for the invoices or accounts payable. Days payable outstanding (DPO) is the average number of days the business takes to pay for the invoices.
A company should not have exceedingly high DPO as it can risk losing its creditors or potential investors.
4. Accounts Receivable Turnover (ART)
Also known as – Debtor Ratio
It’s a ratio to evaluate how efficiently the company collects its debts. The higher the accounts receivable turnover, i.e., the debtor ratio, the more efficient the company is in collecting the payments.
5. Accounts Payable Turnover (APT)
Also known as – Creditor Ratio
It’s a ratio to measure the short-term liquidity. The creditor ratio reflects the frequency with which the business pays its creditors in a given time period.
6. Cash Flow Coverage Ratio (CFCR)
The cash flow coverage ratio is a measure of a business’s capacity to repay its debts using operational cash.
7. Average Days Delinquent (ADD)
Also known as – Delinquent days sales outstanding
The average days delinquent tells the average number of days the sales receipts or invoices stay outstanding before the payment is made. The ADD tells the story of the delinquency trend of the customers.
8. Current Accounts Receivable (CAR)
The current account receivable measures the total amount of the money the debtors owe to the company. Therefore, it includes all the possible payments businesses can receive in a fiscal period.
9. Current Accounts Payable (CAP)
The opposite of current accounts receivable, current accounts payable is the story of the real-time or short-term payments a business needs to make. It considers all the short-term liabilities and obligations the company has to its debtors.
10. Cash Conversion Cycle (CCC)
The business has investments and items in inventory, such as goods and services, that it must convert to cash. The cash conversion cycle is the average number of days or time the business takes to convert the investments and inventory to cash.
11. Working Capital Ratio (WCR)
Also known as – Current Ratio
The working capital ratio is an indicator of the company’s financial strength when it comes to liquidity. It is a ratio of the current assets and current liabilities. A more than one ratio, preferably 1.5 or above, means the company is financially equipped to meet its short-term expenses.
12. Forecast Variance
A measure of the accuracy of the cash flow estimates, the cash flow variance is the deviation from the cash forecasts. Forecast variance is the difference between the cash forecasts and the actual outcome.
13. Total Available Liquidity
At any given date, total available liquidity is defined as the sum of the following:
(i) the total amount of cash and cash equivalents held by the borrower
(excluding cash or cash equivalents pledged to secure letters of credit or otherwise restricted or encumbered in any way);
(ii) the amount equal to
- availability
minus
- the sum of the total outstanding principal amount of revolving loans at that date + the total amount of all outstanding letters of credit.
All the Necessary Calculations for Evaluating a Statement of Cash Flow
Evaluating a statement of cash flow requires doing some critical calculations. Here are some calculations that will come in handy to calculate the operating cash flow, accounts receivable turnover, and more. Remember that there could be different ways to calculate the same entity, such as, for example, operating cash flow. You can use a suitable formula depending on the context.
- Free Cash Flow = Cash from Operations – CapEx
- Free Cash Flow=Sales Revenue − (Operating Costs + Taxes) − Required Investments in Operating Capital
- Operating Cash Flow = Total Revenue – Operating Expenses
- Operating Cash Flow = Operating Income (revenue – cost of sales) + Depreciation – Taxes +/- Change in Working Capital
- Net Change In Cash = Cash From Operating Activities +/- Cash From Investing Activities +/- Cash From Financing Activities
- Working Capital = Current Assets – Current Liabilities
- Forecast Variance = Forecasted Amount – Actual Amount / Forecasted Value
- Debtor Days = Total Debtors / Total Credit Sales *365
- Creditor Days = Total Creditors / Total Credit Purchases *365
- Accounts Receivable Turnover = Total Sales / Average Accounts Receivable
- Operating Cash Flow Ratio = Cash Flow From Operations / Current Liabilities
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = (Current Assets – Inventory) / Current Liabilities
- Debt to Equity Ratio = Total Debt / Shareholders’ Equity
Wrapping It Up
The above article must guide you on how to measure cash flow performance using cash flow metrics and KPIs. That should suffice for the primary and basic analysis purpose for small businesses.
However, for deeper analysis and performance tracking of small, mid-sized, and larger businesses, one should connect to the experts. Take a free consultation from our accounting experts at no cost.