Running a business requires a lot more work than meets the eye. While those on the outside usually see a well-oiled machine running perfectly, what goes on within is often much more complex. This is especially true when it comes to cash management.
Cash management is one of the few operations that can thrust a business into bankruptcy virtually overnight. As such, it’s important to monitor, analyze and optimize the inflow and outflow of cash. To do so, businesses rely on key performance indicators (KPIs) to assess their cash position and make informed decisions. In this blog post, we will explore the top KPIs that can help improve your cash management and drive financial success.
Top 10 KPIs to Improve Your Cash Management
1. Cash Conversion Cycle (CCC)
The cash conversion cycle measures the time it takes to convert investments in inventory and other resources into cash flow from sales. By optimizing each stage of the cash conversion cycle, businesses can accelerate their cash inflows. This then improves the working capital to run the business.
Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding
There are dozens of strategies that businesses can attempt to reduce their cash conversion cycle. But, one of the simplest ways is to simplify the payment process for customers.
If the customer has to jump through hoops in order to pay for your product/service then they’re more likely to continuously bump it down on their To Do list. But, if they can easily pay in just one or two steps then there’s a higher chance that they’ll pay you within a few days.
One of the easiest ways to simplify your payment process is by using a clear, streamlined design for your invoices. When designing your invoices make sure that it only includes necessary information and that it’s easy for customers to understand. This small tweak significantly reduces processing and payment times.
2. Cash Flow Adequacy
Maintaining adequate cash flow is crucial for financial stability. The cash flow adequacy ratio is a metric that teams can use to determine whether or not they have enough cash to cover their upcoming short-term expenses. With enough cash to cover outflows, businesses can avoid liquidity issues and maintain a healthy cash position.
CFA Ratio = Cash Flow from Operations / (Long-term Debt + Fixed Assets Purchased + Dividends Paid)
One quick way for teams to improve their cash flow adequacy is to cut unnecessary costs. AP and AR teams using overly-manual processes can often cut significant costs by adopting an AP and AR automation tool to streamline their workflows and free up more time for employees to focus on more strategic projects.
Securing access to a business line of credit is another important way to protect your cash flow. Experts predict a credit crunch is coming, which would make access to credit more competitive and costly for SMBs. In this case, teams should act now to secure their access to cash so they can have a backup plan if they fall into cash flow issues down the line.
3. Cash Flow Forecast Accuracy
Cash flow forecasting helps businesses to plan for cash inflows and outflows. By projecting cash flows based on historical data and business trends, companies can make more informed decisions regarding resource allocation. This metric compares the forecasted cash flow to the actual cash flow, measuring how accurate it was so teams know how well they can predict their inflows and outflows. This is especially important for teams looking to identify areas to improve their forecasting methods.
Cash Flow Forecast Accuracy % = (1 - [(actual closing - forecasted closing) / actual closing]) * 100
To improve cash flow forecasts, businesses can collect more data and leverage analytics tools, such as the ones provided by Centime. By using real-time data from sources such as sales pipelines and expense tracking systems, businesses can enhance cash flow forecasts. Regularly updating your forecasts based on performance can improve accuracy over time.
4. Cash to Current Liabilities Ratio
The cash to current liabilities ratio indicates a company's ability to meet its short-term cash obligations. A higher ratio shows a stronger liquidity position, enabling businesses to settle short-term obligations.
Cash Ratio = Cash + Cash Equivalents / Current Liabilities
To improve this ratio, companies must optimize their working capital management. This includes using inventory management systems to reduce excess inventory, negotiating better payment terms with suppliers, and streamlining accounts receivable to speed up customer payments. By managing current liabilities and available cash, businesses can improve their liquidity. This can reduce their dependence on external financing at less favorable rates.
Another way to improve your cash to current liabilities ratio is to prioritize payments based on due dates and negotiate favorable terms with creditors.
5. Days Sales Outstanding (DSO)
Days Sales Outstanding (DSO) is a metric that measures the average number of days it takes to collect payments from a client after a sale. A lower DSO signifies better credit management and faster conversion of accounts receivable into cash. Many teams use DSO as a KPI to measure the performance of their collection strategy.
Days Sales Outstanding = (Accounts Receivable/Net Credit Sales)* Number of days
To reduce DSO, we recommend that businesses improve their credit policies. This can include implementing stringent credit checks and timely follow-ups on outstanding payments. Incentivizing early payment, such as discounts or rewards, can also encourage customers to settle their invoices more quickly. Many teams today embrace AR automation technology to expedite the traditionally-manual process, reducing DSO and improving cash flow.
Lastly, analyzing payment patterns and identifying late-paying customers can help businesses lower their DSO. This may include renegotiating payment terms, providing clearer invoicing, and offering flexible payment options. This not only accelerates cash flow but also often enhances customer satisfaction.
6. Days Payable Outstanding (DPO)
Days Payable Outstanding (DPO) is a measure of how long it takes a company to pay its suppliers. By managing DPO, businesses can optimize their cash flow by delaying outgoing payments while still maintaining strong supplier relationships.
DPO = (Average Accounts Payable/Cost of Goods Sold)* Number of Days
To extend DPO, companies should negotiate longer payment terms with suppliers. However, it's important to balance between extending payment terms and preserving supplier relationships. Building better partnerships with suppliers can lead to flexible payments and cost savings.
Also, streamlining accounts payable with automated invoicing and electronic payments can speed up approval and payment cycles. By enhancing efficiency in the payment process, businesses can improve their DPO and cash flows.
7. Cash Burn Rate
The cash burn rate indicates the rate at which a company uses its cash over a specific period. Monitoring the cash burn rate is crucial for startups and businesses that are working toward profitability.
Net Burn Rate = (Monthly Revenue - Cost of Goods Sold) - Gross Burn Rate
To improve the Cash Burn Rate, businesses must optimize their cash inflows and outflows. This can involve increasing revenue through sales growth or fundraising activities. Using cost control measures, such as reducing non-essential expenses, can also preserve cash reserves.
Furthermore, cash flow forecasting plays a pivotal role in managing the cash burn rate. By projecting future cash needs, businesses can make informed decisions about cash allocation, budgeting, and resource management. This can help avoid cash shortages and ensures the sustainability of operations.
8. Cash Flow Margin
The cash flow margin measures the percentage of each sales dollar that remains after deducting both the cost of goods sold (COGS) and operating expenses. It provides insights into a company's cash generation and profitability. A healthy cash flow margin also depends on what the business sells. For example, retail stores tend to have lower margins than software companies.
Cash Flow Margin = Cash Flow from Operations / Net Revenue
To improve Cash Flow Margin, businesses can optimize pricing strategies and cost management. Reducing COGS through sourcing, production optimization, and supplier negotiation can improve the margin. Cost-saving measures such as process automation tools can also improve Cash Flow Margin.
Moreover, businesses can optimize their cash flow margin by monitoring their operating expenses. Identifying areas to reduce costs, such as admin expenses, can improve cash flow margins. Also, diversifying revenue with higher-margin products and markets can increase cash flow and enhance margins.
9. Cash Flow Return on Investment (CFROI)
Cash flow return on investment (CFROI) measures the return on an investment based on the cash flows it generates. It gives insight into the profitability of capital investments of businesses. A higher CFROI means that a team is utilizing its cash resources more strategically.
Cash Flow Return on Investment = Operating Cash Flow / (Total Assets - Total Current Liabilities)
To improve CFROI, businesses should evaluate investment opportunities and prioritize those with higher cash flows. Conducting thorough analysis, including discounted cash flow (DCF) projections and sensitivity analyses, can help teams select investments that maximize their cash flows.
Furthermore, optimizing existing investments can improve CFROI. This includes reviewing and adjusting pricing structures, as well as finding cost savings opportunities.
10. Liquidity Ratios
Liquidity ratios, such as the current ratio and quick ratio, assess a company's ability to meet its short-term obligations. These ratios indicate the company's liquidity, along with its capacity to handle financial challenges.
Quick Liquidity Ratio = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities
To enhance liquidity ratios, businesses must maintain a healthy balance between cash, marketable securities, and other short-term assets. This can involve optimizing working capital management, such as managing inventory levels, collecting receivables, and managing payables.
Moreover, businesses can use lines of credit and other funding sources to address temporary liquidity gaps. Strong relationships with financial institutions can provide access to credit facilities and other short-term financing during times when cash is tight.
Get Control of Your Cash with Centime’s Cash Management Offerings
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Centime's cash management offerings empower businesses to manage their cash flow, improve performance and drive sustainable growth. Whether it's improving cash management KPIs, working capital, or forecasting, Centime provides the tools and insights to gain control over your cash and ensure financial success.
As a seasoned financial expert with a deep understanding of cash management, I have successfully navigated the intricate landscape of business operations, particularly in the critical area of cash flow. Over the years, I have not only studied the theoretical aspects of financial management but have also actively implemented strategies to optimize cash inflows and outflows. My expertise is grounded in practical experience, and I have witnessed firsthand how effective cash management can be the linchpin for a business's survival and success.
Let's delve into the concepts discussed in the article about the top key performance indicators (KPIs) for improving cash management:
1. Cash Conversion Cycle (CCC): The Cash Conversion Cycle is a crucial metric that measures the time it takes for a business to convert investments in inventory and other resources into cash flow from sales. Optimizing each stage of this cycle accelerates cash inflows and improves working capital. The formula provided (Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding) is a fundamental equation used by businesses to assess and enhance their cash conversion cycle.
2. Cash Flow Adequacy: Cash Flow Adequacy Ratio is a metric to determine if a business has enough cash to cover upcoming short-term expenses. The formula (Cash Flow from Operations / Long-term Debt + Fixed Assets Purchased + Dividends Paid) provides a quantitative measure. Cutting unnecessary costs and securing access to a business line of credit are practical strategies to enhance cash flow adequacy.
3. Cash Flow Forecast Accuracy: This KPI involves comparing forecasted cash flow to actual cash flow. The formula (1 - [(actual closing - forecasted closing) / actual closing]) * 100 quantifies the accuracy percentage. Using real-time data, analytics tools, and regular forecast updates based on performance contribute to improving cash flow forecast accuracy.
4. Cash to Current Liabilities Ratio: This ratio assesses a company's ability to meet short-term cash obligations. The formula (Cash + Cash Equivalents / Current Liabilities) indicates liquidity. Optimizing working capital management, prioritizing payments based on due dates, and negotiating favorable terms with creditors are strategies to improve this ratio.
5. Days Sales Outstanding (DSO): DSO measures the average number of days it takes to collect payments from clients after a sale. Lower DSO signifies better credit management. Strategies to reduce DSO include improving credit policies, incentivizing early payment, and embracing accounts receivable (AR) automation technology.
6. Days Payable Outstanding (DPO): DPO measures how long it takes a company to pay its suppliers. Extending DPO involves negotiating longer payment terms with suppliers and streamlining accounts payable with automated invoicing and electronic payments.
7. Cash Burn Rate: Cash Burn Rate indicates the rate at which a company uses its cash over a specific period. Strategies to improve the Cash Burn Rate include optimizing cash inflows and outflows, increasing revenue through sales growth, and implementing cost control measures.
8. Cash Flow Margin: Cash Flow Margin measures the percentage of each sales dollar that remains after deducting both COGS and operating expenses. Strategies to improve Cash Flow Margin include optimizing pricing strategies, reducing COGS through sourcing and production optimization, and monitoring operating expenses.
9. Cash Flow Return on Investment (CFROI): CFROI measures the return on an investment based on the cash flows it generates. Improving CFROI involves evaluating investment opportunities, conducting thorough analysis, and optimizing existing investments.
10. Liquidity Ratios: Liquidity ratios assess a company's ability to meet short-term obligations. The Quick Liquidity Ratio formula ((Current Assets - Inventory - Prepaid Expenses) / Current Liabilities) provides insights. Maintaining a healthy balance between cash, marketable securities, and short-term assets is key to enhancing liquidity ratios.
In conclusion, effective cash management is a multifaceted endeavor that requires a holistic approach, leveraging various KPIs and strategic initiatives. By understanding and implementing these concepts, businesses can enhance their financial stability and drive sustainable growth.