Managing cash flow can be a challenge for small businesses. Many factors come into play and if you don’t have a strategy or system in place, you’ll start to see your cash flow trend in the wrong direction.
At NOVAA, we advise all of our clients to prioritize cash flow metrics as a primary step in cash flow management.
When you fully understand what metrics affect your cash flow, you can leverage these numbers to strengthen it and your business as a whole.
While this is not an all-inclusive list of the metrics that can be used to improve your cash flow, these are five of the most important cash flow metrics we, NOVAA, suggest prioritizing in your startup:
1. Operating Cash Flow (or Cash Flow From Operations)
Operating cash flow (or cash flow from operations) is a measure of the amount of cash generated by a company from normal, core business activities. A positive operating cash flow is the first step toward a successful business.
Typically, this is the first metric found on your cash flow statement. The metric indicates whether or not you are generating a strong enough cash flow to grow.
You can calculate operating cash flow in two ways: direct and indirect.
The direct method is the difference between revenue (inflows) and operating expenses (outflows). Below is the formula using the direct method:
Total Revenue – Operating Expenses = Operating Cash Flow
The indirect method factors in non-cash accounts. Below is the formula using the indirect method.
Operating Income + Depreciation – Taxes + Change in Working Capital = Operating Cash Flow
No matter which method you use, your operating cash flow is found on the cash flow statement, along with cash flow from investing activities and cash flow from financing activities. Cash flow from financing and investing factor in the other business activities included in measuring your overall cash flow.
2. Accounts Receivable Turnover
Accounts receivable turnover is a metric that measures the rate your company collects debt from your customers.
Ideally, you want to have a high turnover rate. This would mean you are collecting debt quickly. A low rate would indicate that customers are not paying in a timely manner, whether it be from:
- Overly flexible payment terms
- Delivery problems
- Unhappy customers
When you prioritize and track this metric, you can see changes over time, which could point to cash flow problems before they become a larger issue.
3. Working Capital
Working capital is a metric that indicates your business’s:
- Operational efficiency
- Short-term financial health
The numbers you need (current assets and current liabilities) to calculate your working capital are found on the balance sheet. Essentially, your working capital is your current assets less your current liabilities.
If your business has a large working capital, you have the ability to move into additional investment opportunities and grow. If your current liabilities outweigh your current assets, your business is at risk of failure.
Working capital can be thought of as a more current indicator of your ability to pay liabilities while cash flow is more of a long-term view. They both work together to provide an overall idea of the financial health of your business.
4. Forecast Variance
Forecast variance is a comparison of your projected numbers to your actuals. When you measure your variance, you can spot areas where you are off track from where you were expecting to be and make adjustments.
Some areas where tracking forecast variance in relation to cash flow may be helpful include:
- Sales (actuals vs forecast)
- Expenses (budget vs actuals)
5. Return on Equity
Return on equity is an ROI metric that measures the shareholder’s return from your business on their investment.
Over time, your return on equity should increase. This would indicate that you are wisely using your investors’ money (working capital). If you aren’t using your money to invest wisely, it can lead to a low return on equity, which is a turn-off for future investors.
Your return on equity can be used to appeal to investors (if needed) and measure how well you are managing your cash flow.
Need Help Tracking the Right Cash Flow Metrics?
Cash flow is the lifeblood of every business. It measures cash inflows and outflows and is a strong indicator of your business’s short-term and long-term financial health. If your cash flow struggles, your business will struggle as well.
While tracking metrics like the ones covered above will provide you with some of the numbers you need for proper cash flow management, outsourcing your accounting to an expert will bring you the greatest return.