Cash flow can make or break a business. Even when you’re getting good sales and have high profit margins, it’s easy for accessible cash to run dry.
To stay on top of your financials, there are a few key cash flow metrics and KPIs you can track that will help you make the right decisions and avoid insolvency or liquidation. Here’s a look at our top seven.
- Learn more: Inventory Accounting Guide
What are cash flow metrics?
Cash flow metrics are measurements implemented by a business to record or predict money as it flows in and out of the company. They allow businesses to track and understand their cash flow, so they may make better-informed decisions about where and how they spend it.
As cash is constantly moving in and out of an organisation, calculating exactly how much you have in the business at any one point in time is crucial. Cash flow metrics can tell you whether you have enough money to pay suppliers, employees, lenders, and other operational expenses, and also see whether you may have enough free cash to spend on new opportunities or investments.
Cash flow metrics play a critical role in determining company spend and cost-cutting strategies.
Why is it important to track cash flow metrics?
Cash flow metrics are important because they provide accurate insights into the financial performance of an organisation. These insights can help with decision-making by using the right KPIs to get clear on what you’re wanting to achieve. They can also assist with business growth.
A quick recap on cash flow basics
There are three categories of cash flow. Any analysis of cash flow metrics needs to have cash statements from each one.
The 3 categories of cash flow include:
- Operating cash flow. All the typical cash flows of a business fall under operating cash flow. This includes income from sales and overheads such as employee wages, suppliers, and utilities.
- Investment cash flow. These are funds spent on things like capital investments, purchase of stock, securities of another company or treasury. Income is generally made from interest and/or dividends.
- Financing cash flow. This category covers funds that come from a business’s owners, investors, and creditors. For example, shares or bonds that are issued or taken out.
Learn more: 19 Key Inventory Management Statistics & Benchmarks
7 cash flow metrics & KPIs to start tracking
The cash flow metrics and KPIs below can be tracked to help you understand and optimise the financial standings of your business. Before you decide which ones you’ll focus on, consider your current business goals and challenges.
Days Sales Outstanding (DSO)
Average Receivables in a Period / Total Credit Sales in the Same Period × Number of Days in the Period = DSO
Days Sales Outstanding measures the average number of days that it takes a business to collect payment after a sale has been made.
DSO is an important cash flow metric to measure because it shows whether your cash conversion cycle is short or long. If it’s long, you may need to adjust the way you collect payments as this could lead to poor cash flow.
It’s important to benchmark your DSO against industry standards, as this will provide correct insights as to what you should be aiming for.
How to improve your Days Sales Outstanding:
- Offer incentives for paying early.
- Provide preferred payment methods for customers.
- Have strategies for dealing with consistently late payers.
Tracking multiple cash flow metrics and KPIs will give you the most holistic picture of your business's financial health.
Days Payable Outstanding (DPO)
Average Accounts Payable / Cost of Goods Sold × 365 = DPO
Days Payable Outstanding is the opposite of DSO. It measures the average number of days a business takes to make cash payments owed to suppliers or vendors (as opposed to purchases made using credit).
DPO is an important cash flow metric because, if it’s too low, you might be jeopardising your free cash flow or not taking advantage of available credit terms. And while a high DPO is more desirable (as it provides better short-term liquidity), there is always the risk of losing good suppliers or having restrictions placed on orders.
How to improve your Days Payable Outstanding:
- Increase your bargaining power by building long-term supplier relationships.
- Where possible, align your DPO with your average supplier payment terms.
- A lower DPO may work in your industry if you’re able to get early payment discounts.
Operating Cash Flow
Total Cash Received for Sales - Cash Paid for Operating Expenses = Operating Cash Flow
Operating Cash Flow helps you to understand how much your business is earning from its normal, daily operations. The underlying objective is to get a handle on an organisation’s profit, and if there could be any issues in the long term. If you’re operating a negative cash flow, you’ll need to consider cost-cutting or identify areas of improvement.
Operating cash flow is an important metric to measure as it can indicate how successful and sustainable a business is at any one time, via its normal operations. This could be useful for potential investors if you’re wanting to secure a loan, or simply to get clear on whether you’re running at a profit or loss.
How to improve your Operating Cash Flow:
- Analyse whether you could be collecting payments in a timelier manner.
- Reduce spending where possible or look to other revenue streams.
- Increase inventory turnover and look to raise prices if you haven’t in a while.
Accounts Receivable Turnover (ART)
Net Credit Sales / Average Accounts Receivable = ART
Accounts Receivable Turnover measures how many times a business’s receivables are turned over in a given period of time (and for many organisations, this is calculated annually). Its focus is to understand how well an organisation is managing the credit given to its customers, by measuring how long it takes to then collect the debt.
ART is important because it is a reliable indicator of how fast your business gets paid by your customers. This will allow you to manage your own debts and payments, as well as understand areas for improvement.
How to improve your Accounts Receivable Turnover:
- Review your current credit policies and processes (including the look and layout of your invoices).
- Embrace technology to streamline collection, but don’t make payment too confusing for customers.
- Incentives (or late payment fees) could help bring in payments faster.
Keeping track of the cash flow metrics mentioned in this list can help your business side-step insolvency and stay afloat during high volume sales periods.
Accounts Payable Turnover (APT)
Total Cost of Sales for Period / Average Accounts Payable for that Period = APT
Accounts Payable Turnover (also known as a creditor’s turnover) enables you to measure short-term liquidity, showing how often you’re paying your creditors and suppliers across a particular time period.
If you have a high APT, it may mean that you don’t have suitable credit lines, or that you aren’t using them to your advantage. And while a low APT is desirable, there is the possibility of it risking your relationship with suppliers (just like with a low DPO).
APT is important to measure because it shows whether the revenue your business is generating is enough to pay suppliers in an adequate time frame. It also allows you to check that you aren’t paying too quickly and missing out on keeping cash in your business.
How to improve your Accounts Payable Turnover:
- Build long-term relationships to negotiate more desirable payment terms with your suppliers.
- Manage your business’s liquidity effectively to ensure you have available funds in the event of unexpected events or seasonal impacts.
- Don’t take a low or high APT at face value. They both have positive and negative elements, so you need to ensure it’s working for your business.
Cash Conversion Cycle (CCC)
Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding = CCC
The Cash Conversion Cycle is about understanding how many days it takes a business to turn inventory and investments into cash –from production and sales to receiving payment from a customer.
A low CCC typically means an organisation has greater liquidity because it is collecting cash quickly.
CCC is important because it shows a business how efficient it is at turning a product and/or service into cash. The less time money is held up in accounts receivable and inventory, the better it is for cash flow and business profitability.
How to improve your Cash Conversion Cycle:
- Make delivery of your product faster. The quicker you get inventory out of your warehouse and to your customer, the sooner you can invoice and get paid.
- Like a few of the metrics above, encouraging prompt payment from customers can be beneficial, by using incentives such as early payment discounts.
- Make it easier for customers to pay, with a variety of payment methods and simple, clear invoicing.
Forecast Variance
Forecasted Value – Actual Value / Forecasted Value = Forecast Variance
The Forecast Variance cash flow metric measures actual cash flow versus what was forecasted. The reason for making this calculation is to help businesses understand how accurate their estimations were when it comes to cash flow at a certain point in time.
It’s important to use Forecast Variance because it will allow you to make better business decisions, as well as be aware of which parts of your business are performing well.
If you have a high forecast variance, you likely need to reassess the way you forecast your cash flow. A low forecast variance means your business is doing a good job in predicting future cash flow, so you can rely on making the right decisions for performance and growth.
How to improve your Forecast Variance:
- If you have several different areas in your organisation, calculate and review variances separately.
- Use scenario planning to consider a variety of possible outcomes, particularly when it comes to unexpected events, external influences, and seasonal trends.
- Ensure you’re using highly accurate and up-to-date data.
The above list is by no means exhaustive. There are many other metrics to measure your cash flow, but these are the most common ones which businesses will use in their day-to-day operations.
Performing a cash flow analysis will help you determine which areas of your business require more funding to sustain maximum growth.
5 effective cash flow analysis tips and tactics
Here are five tips to help with the analysis of your cash flow metrics:
- Don’t confuse cash flow with profit. These are two different things. Profit is what’s left after all expenses have been paid and cash flow illustrates the net flow of cash in and out of a business at a specific time point. So if you get paid by multiple customers one day, it may look like you have made a huge profit. But the very next day, much of this could go back out to pay suppliers and employees.
- Negative cash flow isn’t always a bad thing. Before you panic, the negative cash flow could be due to investing in growth or products. Always weigh up your operating cash flow versus investment or financial cash flow; they all could tell different stories about what’s happening in your business.
- Remain cautious of positive cash flow. Just as negative isn’t always bad, positive isn’t always good. You need to ensure that anything positive happening in one area of your business isn’t negatively impacting the other. For example, if you’re selling assets to pay operating expenses.
- Use a mix of metrics to get clear on your cash flow. It’s important to include a variety of metrics in your cash flow analysis, as each will help you uncover areas of your business where you could make changes or improve your operations.
- Prioritise your cash flow analysis. It can be easy to put things like cash flow to the bottom of the to-do list. But by analysing various cash flow metrics regularly, you’ll reap the benefits. It helps you to strategise and prepare for any issues or challenges in the foreseeable future.
Key takeaways: Cash flow metrics and KPIs
- Cash flow is an integral part of your business which is why it’s crucial to accurately keep track of it.
- Cash flow metrics can help identify areas of the business where there may be issues, as well as provide insights into growth opportunities.
- Measure what it’s important to your organisation and determine how you can continue to improve on those KPIs.
