As a business owner, keeping track of your company’s financial performance is crucial. One of the most important metrics to measure the financial health of your business is cash flow. Cash flow Key Performance Indicators (KPIs) can provide insights into how efficiently your business generates and manages its cash, and can help you make informed decisions to improve your company’s financial performance.
In this article, we’ll cover the essential cash flow KPIs that every business should track, and how you can use them to manage your business’s finances effectively.
What are Cash Flow KPIs?
Cash flow KPIs are metrics that help businesses measure the inflows and outflows of cash within a specific period. These metrics provide valuable insights into how efficiently the company generates and manages its cash, and whether it has enough cash to meet its financial obligations.
Cash flow KPIs are essential for businesses of all sizes, as they help you monitor your cash position, identify cash flow issues, and make informed decisions to improve your business’s financial health.
Here are the essential cash flow KPIs that every business should track:
1. Operating Cash Flow (OCF)
Operating cash flow (OCF) is the cash generated or used by a company’s normal business operations. It measures how much cash a company generates or consumes from its operations, excluding any financing or investing activities.
OCF is a vital KPI because it shows how well a company can generate cash from its primary business activities. A positive OCF indicates that the company is generating enough cash to fund its operations and investments. A negative OCF, on the other hand, suggests that the company is consuming more cash than it generates, which could lead to financial difficulties.
2. Free Cash Flow (FCF)
Free cash flow (FCF) is the cash generated or used by a company after accounting for all capital expenditures (CAPEX). FCF represents the amount of cash that a company can generate after spending on maintenance, expansion, and other capital expenses.
FCF is a crucial KPI because it indicates the amount of cash that a company can generate for investments or distributions to shareholders. A positive FCF means that the company has excess cash to invest in growth opportunities, pay down debt, or distribute to shareholders. A negative FCF suggests that the company may need to borrow or raise capital to fund its operations or investments.
3. Cash Conversion Cycle (CCC)
Cash Conversion Cycle (CCC) measures the time it takes for a company to convert its investments in inventory and accounts receivable into cash. CCC is calculated by adding the days inventory outstanding (DIO) and the days sales outstanding (DSO), and subtracting the days payable outstanding (DPO).
CCC is an important KPI because it shows how efficiently a company can convert its investments in inventory and accounts receivable into cash. A shorter CCC indicates that the company is converting its investments into cash quickly, which improves its cash position. A longer CCC suggests that the company is holding too much inventory or is struggling to collect payments from customers, which can hurt its cash position.
4. Net Working Capital (NWC)
Net Working Capital (NWC) measures the difference between a company’s current assets and current liabilities. NWC represents the amount of cash that a company can generate from its current assets to fund its current liabilities.
NWC is a crucial KPI because it shows how much cash a company has available to fund its short-term obligations. A positive NWC indicates that the company has enough current assets to cover its current liabilities, which is a good sign. A negative NWC suggests that the company may struggle to meet its short-term obligations.
5. Debt to Equity Ratio (D/E Ratio)
Debt to Equity Ratio (D/E Ratio) measures the amount of debt a company has relative to its equity. It is calculated by dividing a company’s total debt by its total equity.
D/E Ratio is a critical KPI because it shows the extent to which a company’s operations are being funded by debt. A high D/E Ratio suggests that the company has more debt than equity, which could lead to financial difficulties in the long run. A low D/E Ratio, on the other hand, indicates that the company has a more conservative financial structure.
6. Current Ratio
Current Ratio measures a company’s ability to pay its short-term obligations using its current assets. It is calculated by dividing a company’s current assets by its current liabilities.
Current Ratio is an important KPI because it shows whether a company has enough current assets to cover its current liabilities. A ratio of 1 or higher suggests that the company has enough current assets to pay off its current liabilities. A ratio below 1 indicates that the company may struggle to pay off its short-term obligations.
7. Quick Ratio
Quick Ratio, also known as the acid-test ratio, is similar to the current ratio but excludes inventory from the calculation. It measures a company’s ability to pay its short-term obligations using its most liquid assets.
Quick Ratio is a useful KPI because it shows whether a company has enough cash and liquid assets to cover its short-term obligations. A ratio of 1 or higher indicates that the company has enough liquid assets to pay off its current liabilities. A ratio below 1 suggests that the company may struggle to meet its short-term obligations.
8. Gross Margin
Gross Margin is the difference between a company’s revenue and the cost of goods sold (COGS). It represents the amount of money that a company has left over after paying for the production costs of its products or services.
Gross Margin is a critical KPI because it shows how efficiently a company is producing its products or services. A high gross margin indicates that the company is generating a healthy profit on its products or services. A low gross margin suggests that the company may be struggling to cover its production costs.
9. EBITDA Margin
EBITDA Margin measures a company’s operating profitability before accounting for interest, taxes, depreciation, and amortization. It represents the amount of money that a company generates from its operations before accounting for non-operating expenses.
EBITDA Margin is a useful KPI because it shows how efficiently a company is generating profits from its operations. A high EBITDA Margin indicates that the company is generating healthy profits from its core operations. A low EBITDA Margin suggests that the company may be struggling to generate profits from its core operations.
10. Return on Investment (ROI)
Return on Investment (ROI) measures the amount of return that a company generates on its investments. It is calculated by dividing a company’s net income by its total assets.
ROI is an important KPI because it shows whether a company is generating healthy returns on its investments. A high ROI indicates that the company is generating significant returns on its investments. A low ROI suggests that the company may be struggling to generate returns on its investments.
11. Interest Coverage Ratio
Interest Coverage Ratio measures a company’s ability to pay interest expenses on its debt. It is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expenses.
Interest Coverage Ratio is an important KPI because it shows whether a company is generating enough earnings to cover its interest expenses. A high ratio indicates that the company is generating healthy earnings to cover its interest expenses. A low ratio suggests that the company may struggle to cover its interest expenses.
12. Debt Service Coverage Ratio
Debt Service Coverage Ratio measures a company’s ability to repay its debt obligations. It is calculated by dividing a company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) by its total debt service (interest and principal payments).
Debt Service Coverage Ratio is a useful KPI because it shows whether a company is generating enough earnings to cover its debt obligations. A high ratio indicates that the company is generating healthy earnings to cover its debt obligations. A low ratio suggests that the company may struggle to repay its debt obligations.
13. Cash Balance
Cash Balance measures the amount of cash that a company has on hand at a specific point in time. It is a simple but essential KPI that shows the company’s liquidity position.
Cash Balance is a critical KPI because it shows whether a company has enough cash on hand to meet its short-term obligations. A low cash balance suggests that the company may struggle to pay off its short-term obligations.
14. Accounts Receivable Days
Accounts Receivable Days measures the average number of days it takes for a company to collect payments from its customers. It is calculated by dividing the accounts receivable balance by the average daily sales.
Accounts Receivable Days is an important KPI because it shows how efficiently a company is collecting payments from its customers. A shorter collection period indicates that the company is collecting payments quickly, which improves its cash position. A longer collection period suggests that the company may struggle to collect payments from its customers, which can hurt its cash position.
15. Accounts Payable Days
Accounts Payable Days measures the average number of days it takes for a company to pay its suppliers. It is calculated by dividing the accounts payable balance by the average daily purchases.
Accounts Payable Days is a useful KPI because it shows how efficiently a company is paying its suppliers. A longer payment period indicates that the company is holding onto its cash for longer, which improves its cash position. A shorter payment period suggests that the company may be paying its suppliers too quickly, which can hurt its cash position.
Conclusion
Cash flow KPIs are essential metrics for measuring the financial health of your business. By tracking the essential cash flow KPIs, such as Operating Cash Flow, Free Cash Flow, Cash Conversion Cycle, Net Working Capital, Debt to Equity Ratio, Current Ratio, Quick Ratio, Gross Margin, EBITDA Margin, Return on Investment, Interest Coverage Ratio, Debt Service Coverage Ratio, Cash Balance, Accounts Receivable Days, and Accounts Payable Days, you can ensure that your business has enough cash to meet its financial obligations, identify cash flow issues, and make informed decisions to improve your company’s financial health.