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Cash Flow
This week’s blog post was inspired by a recent chat with a business owner, and it's a conversation I have way too often. It went something like this:
Business Owner: “I don’t need management accounts or KPIs. I’ve been doing fine for 10 years without them.”
Me: “How do you manage your cash flow?”
Business Owner: “Simple. I look at the bank balance every day.”
While this business had done fairly well, a lot of its success could be attributed to luck rather than strategic financial management. Relying solely on the cash in the bank today is risky and can lead to a sudden downfall. Imagine how much better they could have done with a proper finance function in place.
Nobody can successfully manage their business’s cash flow by just looking at their bank balance. Here’s why:
Let’s dive into some essential cash-related KPIs to help you get on top of your cash management. Remember, these should complement, not replace, a cash flow forecast.
Formula: Operating Cash Flow = Net Income + Non-Cash Expenses + Change In Working Capital
OCF shows the cash you generate from day-to-day operations. It excludes investments and loans, making it a core indicator of business health.
Formula: CCC = Average Stockholding Days + Average Receivable Days - Average Payable Days
This KPI monitors how long it takes to get paid, pay suppliers, and how long you hold stock.
Liquidity means the ability to find cash to pay short-term debts. Here are three ways to track it:
These ratios show how well you can cover short-term debts. A ratio of 1-3 is healthy, below 1 is risky, and above 3 suggests excess cash that could be better invested.
Formula: Free Cash Flow = Operating Cash Flow - Capital Expenditures
FCF shows what’s left after maintaining or expanding your Fixed Assets, vital for growth. It indicates available cash for debt, dividends, or reinvestment.
Formula: CFCR = Operating Cash Flow / Total Debt
This ratio, considering both short and long-term debt, shows the business’s ability to cover its obligations from operations. A ratio above 1.5 is generally good.
Essential for start-ups, these measures help decide on investment needs and timing.
Set a target of having several months of expenses in the bank. This straightforward measure can boost confidence and facilitate growth decisions.
Always consider gross and net profit margins to better understand your cash position. Positive cash flow without profit is rare.
While this list may seem overwhelming, picking the right KPIs for your industry and business is crucial. Not every KPI needs to be monitored monthly, but each offers a unique perspective on your financial health.
Effective cash flow management is about more than just tracking your bank balance. Using these KPIs can provide a clearer, more comprehensive view of your financial health, helping you make better, more informed decisions for your business.
Remember, managing cash flow isn’t just about survival; it’s about unlocking the full potential of your business. If you need help getting started, Crisp Accountancy is here to guide you every step of the way. Let's transform your financial data into your competitive advantage.