9 indicators to use for cashflow analysis
Cash flow is the lifeblood of any business. It is imperative that we have a system to analyse and manage the cashflow.
So lets look at some important key elements to cash flow management and analysis. Cash has a cycle through a business. Each dollar or revenue incurrs direct costs. After this there are other variable costs and overheads which are met. But from this net income a business must pay its taxes and any loans or other finance obligations. It is the complete understanding of the cycle of cash in a business that leads to great cash flow management.
Working capital is that which is difference between current assets and current liabilites. Current assets include cash, inventory, accounts receivable and current liabilities include accounts payable and other short term finance facilities.
Accordingly we must calculate the average days it takes to collect our accounts receivable and the time it takes to pay the accounts payable. Also it is important to measure how often we turnover the inventory or stock. Each dollar of stock is a dollar less of cash. The faster we turn over the stock the better the cash flow will be. If we are turning the stock over fast then we are making the dollars we have invested in the stock work harder for us.
So from this we are measuring :-
- Debtors (accounts receivable) days
- Creditors (accounts payable) days
- Inventory days
From this we can then calculate two more important measures :-
- Working capital cycle – which is Debtors days + Inventory days – Creditors days
- Working capital % – which is ((Accounts receivable + Inventory – Accounts payable)/Revenue * 100)/365 * days in period.
The higher the working capital cycle the more costly it is to fund.
After this we then need to look at the situation from an overall perspective. This can be done by calculation the cash from operations and the net cash income. Cash from operations means the cash generated prior to interest,tax, asset purchases and any dividends or drawings. Net Cash income is the cash left after the payment of all obligations.
Related to these we can calculate the profit to cash conversion ratio. This is the percentage of Earning before interest and tax that is converted into cash after operations. This can indicate the connection between cash and profit. But remember profit is not cashflow.
So the three extra things to look at are :
- Cash after operations
- Net Cash Income
- Profit to cash conversion ratio
Lastly we can look at:
- cash wastage.
This is where we compare the growth in accounts receivable, Cost of Goods sold and Operating Expenses to revenue growth. Growth is in excess of revenue growth then this is cash wastage. If growth in inventory is more than Cost of Goods Sold gorwth it is considered waste. Whilst a growth of accounts payable which is less than Cost of Goods sold this is also considered waste. The cash wastage is unsustainable growth.
This is on overview of cash flow analysis and if you have any questions please contact me.
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