Businesses need cash flow to survive. A healthy cash flow is often the key to a business surviving challenging seasons and taking advantage of growth opportunities.
Every business owner understands the importance of cash. A business needs money to pay its bills, staff and suppliers and reinvest into the business. Some companies are affected by seasonal trends. Others have irregular customer payments. All businesses are affected by business expenses like rent, insurance and inventory.
You might wonder what a healthy cash flow means as a business owner.
Some key metrics can help you measure your business’s health if you want to improve your cash flow. We’ll discuss those metrics and how you can interpret them for your business.
Three Key Cash Flow Metrics
There are a variety of cash flow metrics that business owners can use to get a snapshot of their business’s financial health.
These metrics can help you uncover what is happening with cash in your business.
Understanding your cash flow metrics can help you answer questions such as:
- Do you have enough cash to pay your debt?
- How much cash is your business retaining for growth?
- What areas can you improve to increase cash in your business?
These metrics can help you clue into how your business is doing. However, analyzing these metrics over time and in conjunction with the rest of your business is essential. Your accounting team or advisors can help you determine whether they tell you the correct information about your business.
Operating cash flow ratio
One metric to track is the operating cash flow ratio to measure how much cash your business generates relative to its short-term or current liabilities.
A simple way to calculate this is to take your business’s revenues, deduct any cash expenses, then divide the result by your current liabilities. The result shows how often your operating cash flow can pay for short-term liabilities.
Generally, the higher this number, the better it is for the business.
A healthy business should have an operating cash flow ratio of at least 1.5, which means that for every $1 expense, the company generates $1.50 in cash from operations.
Cash Conversion Cycle
Another metric business owners can use to assess their cash flow is the cash conversion cycle.
This metric measures the business’s days to convert its inventory into cash. You’ll need various line items from your financial statements to determine how long your inventory, sales and payables stay outstanding.
If your business sells physical items or extends credit to customers, this metric can help you understand how efficient your business is at converting inventory into cash. A shorter cycle means the company collects outstanding receivables quickly and does not hold too much inventory. Typically, the faster the cycle, the healthier your cash flow.
Working Capital Ratio
Finally, the working capital ratio measures a business’s ability to pay its short-term obligations. To calculate this, you’ll need to take your business’s current assets and subtract its current liabilities.
A positive working capital ratio is a good start for most businesses. Conversely, a negative working capital ratio can mean that there is a risk the company will not meet its short-term obligations.
A business with a healthy working capital ratio will have enough assets to cover its short-term obligations.
Keeping an eye on your working capital ratio can help you decide what cash cushion you want in your business to make sure that it can
For some businesses, however, a working capital ratio that is too high can mean that there is too much cash on hand, and you might want to think about deploying it for potential growth opportunities.
How to keep your cash flow healthy?
These cash flow metrics are a good starting point to help uncover how your business is doing regarding its cash flow. However, the metrics above are not an exhaustive list of analytics to understand your business cash flow situation.
Here are some tips that can help you maintain a good cash flow.
Regular Review and Forecasting
The first step to improving your business’s cash flow is understanding how it generates and uses the money.
It is vital to take the time to review your cash situation regularly. Regular reviews can alert you to any shortfalls and allow time to create a plan to mitigate any risks.
A cash flow forecast is a great tool to help you plan for future expenses and income. Start by looking at your current cash balances, and then prepare for any upcoming cash inflows and outflows. You will be able to see if you need cash in the short term to fill in any gaps between the money going out versus coming into the business.
Maintain Cash Reserves
Access to a healthy cash cushion can help improve your business’s cash flow. This might mean always having a certain amount as cash in your accounts for your business. Other companies might have access to a line of credit or additional short-term financing when they need it urgently.
Most businesses need a healthy cash cushion to fall back on in case of an unexpected expense or a slowdown. As your business grows and evolves, the healthy amount will continue to change.
Find professional help
If you’re struggling to improve your business’s cash flow, seek professional help. Your accountant or business advisor can help you. Several professionals specialize in helping businesses with their cash flow, such as certified public accountants (CPAs) and financial advisors.
Cash flow is crucial to the health of any business. By monitoring key cash flow metrics, you can get a good idea of your business’s financial health and make changes to improve your situation.
Contact Edelkoort Smethurst CPAs LLP in Burlington for Expert Financial Advice
If you need personalized advice on improving your cash flow, a skilled financial professional can help you find opportunities to bolster your business, even in times of uncertainty. At Edelkoort Smethurst CPAs LLP, our financial and industry experts can provide you with the support and advice you ned, tailored for your business. To learn more about how Edelkoort Smethurst CPAs LLP can provide you with the best accounting expertise, contact us online or by telephone at 905-517-2297.