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.
The Three most important things to measure in any business.
“The three most important things to measure in any business are customer satisfaction, employee satisfaction and cash-flow” Jack Welch former ceo of GE.
I don’t agree with all that Jack says or did in his tenure at GE however on this point I am in total agreement.
Customers who are not happy will buy elsewhere. Employees who don’t enjoy working for your business will move on and work for your competitors and the replacement employee will be costly to replace. Lastly if a business does not completely understand its cashflow and is totally in control of it then the business growth can suffer.
Measuring customer satisfaction is more than just a quick survey from a call centre. We need to understand whether the customer is truly satifised with the complete experience in dealing with the business. We need to ask the right questions in the right manner. Customer surveys can work if carefully desgined. However there may be other ways to measure customer satisfaction eg in a professional service firm it would be appropriate to measure the number of referrals. A customer will only refer if they are happy. Singapore Airlines measure the number of complaints to the number of compliments ratio to address this issue. Whatever the measure everybody needs to understand it and then it must be tracked consistently.
Employee satisfaction can also be measured by a carefully executed survey. Unfortunately many of these surveys are not properly designed or carefully executed. Also there are other measurements that can be useful eg staff turnover rate (this needs to be tailored for each level of the organisation). Again whatever the final tool, everybody must understand the metric and then it must be consistently measured and reviewed.
Lastly a business must understand the cash-flow cycle. There are a number of operational and capital impacts on cashflow. To manage a business it is necessary that this is understood. Accounts receivable, accounts payable, new equipment, new loans, repaying loans and other finance obligations, owners drawings and contributions are only part of the equation. The complete cashflow of the business must be managed at a minimum each week if not daily.
Also some of the component parts need constant measurement eg debtors and creditors days. Recently in a business they had not previously being measuring debtors days. When I started it was 43 days. Purely because they started measuring it and the accounts staff and the owner were suddenly aware they took action and now the debtors days stand at 29. This has lead to a significant improvement in cash-flow.
What systems to you have to measure customer satisfaction, employee satisfaction and cash-flow?
Cash is King
Whether we in Australia go into a technical recession or not is somewhat irrelevant. There is no doubt there has been a significant slowdown in our economy. This is likely to continue for some time into 2009. So what does this mean to business. There is a couple of important consequences however here I will only cover one. ( will expand on the other consequence in a future blog post).
Cash is king.
A business must pay particular attention to cashflow when the economy turns. There will be greater pressure from clients who delay their payment a little more than normal. Also creditors may be on the back of small / medium business to ensure that they collect their money earlier than usual.
So this is a time for business to review there credit terms, look at their systems to ensure prompt collection of debtors and review any options with respect to creditors. It is critical to understand in detail the working capital requirements of the business and be measuring this regularly. Working capital shortage can cruel a profitable business.
What is your working capital cycle? How long does it take from the moment work is in the door, stock on the floor until you have the cash from your clients? Are there any ways to reduce this timeframe?
Remember – measure what matters – cash is king.
-
Subscribe to Major Focus Group
Or, subscribe via email:
-
Subscribe to our FREE newsletter, The Focal Point and get your FREE copy of How to have a Focused Business.
We respect your privacy: No spam mail and you can unsubscribe at any time.