Handling cash flow is absolutely vital to the survival of any business, yet it continues to be a major stumbling block for entrepreneurs and financial managers. The figure is staggering – around 82% of small businesses that fail do so because of poor cash flow management, which is why measuring the most important cash flow metrics is so indispensable. Not keeping a close eye on aspects like operating cash flow, accounts receivable, net working capital, and free cash flow may lead to cash shortages, slowed growth due to missed opportunities, and even bankruptcy.
7 Essential Cash Flow Metrics for Business Success
By understanding and keeping track of these numbers, business owners can see exactly how much cash they have available. This clarity helps them make smarter investment decisions while keeping the company financially stable. These seven cash flow metrics are essential for monitoring a business’s financial health and supporting its growth plans:
Operating cash flow
On the cash flow statement, operating cash flow (OCF) is frequently a major item. Although it tends to omit interest and investment returns, it records a company’s cash flows through revenue creation and expense payments.
There may be more opportunities for a business to invest in expansion if its operating cash flow is high. A business with a low or negative flow, on the other hand, may be endangering its current operations in addition to having less capacity for investment.
OCF = Net income + Non-cash costs +/- adjustments to net working capital.
DSO = Accounts receivable x Number of days in measurement period / Total credit sales.
For instance:
Let’s say a company announces $100 million in net income, $20 million in non-cash expenses, and a $50 million rise in working capital.
OCF = $100 million + $20 million − $50 million = $70 million.
This means the business generated $60 million in cash from its operating activities during the period.
Working capital ratio
The difference between a company’s current assets and current liabilities is known as working capital. The working capital ratio (WCR) is calculated by dividing current assets by current liabilities. This offers a gauge of a business’s overall operational effectiveness and the state of its short-term finances. It could also serve as a guide for strategies aimed at optimizing working capital.
The sector affects the typical working capital ratios. Generally speaking, a value below one can be seen as a sign that a company is unable to pay off its debts with its available working capital. A ratio above two may suggest that a company is hoarding money, even if a figure between 1.2 and 2 is usually regarded as good.
Working Capital Ratio = Current Assets / Current Liabilities
Example:
A company holds $12 million in current assets while having $7 million in current liabilities.
$12 million / $7 million = 1.7
A ratio of 1.7 means the company has $1.70 in assets for every $1.00 in liabilities—considered financially healthy.
Free cash flow
Free cash flow refers to the money a company keeps after it has paid for its daily operations and capital expenses. This metric is more representative of the company’s real cash position as it shows the cash that can be used to repay debt, make dividend payments, or invest in growth opportunities.
Free cash flow = Operating cash flow – Capital expenditures
Example:
A manufacturing company is generating $60 million in operating cash flow and spending $15 million on capital expenditure.
FCF = $60 million − $15 million = $45 million
The business has $45 million available for debt repayment, dividends, or reinvestment.
Days payable outstanding
Days payable outstanding (DPO) gauges how long it typically takes a business to pay its creditors and suppliers.
Paying invoices quickly is indicated by a low DPO, which may be a sign of less-than-ideal working capital management, but it may also mean that the company is utilizing early payment discounts. Since it increases the company’s available working capital, a higher DPO indicates that the business is taking longer to pay its obligations.
DPO = Accounts payable x Number of days in period / Costs of goods sold
Example:
The company has accounts payable that amount to $8 million, and the cost of sales is $30 million. The time period for the measurement is one year (365 days).
DPO = $8 million × 365 / $30 million = 97 days
It takes this company 97 days on average to pay its suppliers.
Days sales outstanding
The opposite of days payable outstanding, days sales outstanding (DSO), calculates how long it typically takes a company to collect its accounts receivable from clients.
A short DSO means that the company is able to collect its receivables quickly and thus provides funds to support its operations and expansion. A long DSO, on the other hand, shows that the collection of receivables is slow and, as a result, the company may have less working capital and its cash flow management may be less effective.
DSO = Accounts receivable X Number of days in measurement period / Total credit sales
Example:
The accounts receivable of a company stand at $13 million, and net credit sales are $60 million. The measurement period is one year (365 days).
DSO = $13 million × 365 / $60 million = 79 days
On average, it takes 79 days to collect receivables.
Cash conversion cycle
The time it takes for a business to turn cash into inventory and inventory back into cash is known as the cash conversion cycle (CCC). As a result, it shows how well the business’s overall working capital management strategy—which takes into account the processes of sales, inventory control, and purchasing—is operating. A company’s capital can be used elsewhere to support expansion if its CCC is shorter, since less of it will be locked up in inventory.
DSO, DPO, and days inventory outstanding (DIO, the average number of days a business retains inventory before converting it into revenues) are used to compute CCC. Enhancements in any of these three variables can have a favorable impact on the CCC.
Cycle of cash conversion = DIO + DSO – DPO
Example:
Within a single year, a company holds inventory worth $4 million and has a cost of sales of $25 million, resulting in a DIO of 50.4 days. The company also has a DSO of 80.25 days and a DPO of 78 days.
CCC = 50.4 + 80.25 − 78 = 52.65 days
This means it takes the company 52.65 days to turn its investment in inventory into cash.
Sustainable growth rate
A cash flow indicator called the sustainable growth rate (SGR) illustrates how quickly a company may expand using its own income without taking on further debt. As a result, it is a helpful indicator for figuring out the business’s long-term growth plan.
SGR is computed by multiplying return on equity, which compares net income to shareholder equity and measures a company’s profitability, by the retention ratio, which is the percentage of earnings retained in the business. A high SGR may suggest that a company is well-positioned for self-funded expansion; however, this situation is typically unsustainable over an extended period of time.
SGR = Return on Equity (ROE) × Retention Ratio
Where:
- ROE = Net income / Average shareholders’ equity
- Retention ratio = (Net income – Dividends) / Net income
Example:
If a company earns $25 million in net income over a year and has $100 million in shareholders’ equity, while paying $12.5 million in dividends, here’s what it looks like: The return on equity (ROE) is 25% ($25 million / $100 million), and the retention ratio—the portion of earnings kept in the business—is 50% ($25 million – $12.5 million) / $25 million). This means the company’s sustainable growth rate is 12.5%.
25% (Return on equity) x 50% (Retention ratio) = 12.5% (Sustainable growth rate)
FAQs on Cash Flow Metrics
Below are some frequently asked questions on cash flow metrics:
Why is monitoring cash flow important?
Monitoring cash flow is crucial because it helps identify potential cash shortages early, manage expenses effectively, ensure funds are available for daily operations, and plan for future investments or growth opportunities. It should be reviewed regularly—at least monthly, and ideally weekly for businesses with high transaction volumes or tight liquidity.
What are cash flow metrics?
Cash flow metrics refer to measurable indicators derived from a company’s cash flow statement that help in monitoring cash movement, assessing accounts receivable, analyzing net working capital, and facilitating forecasting.
What is the difference between cash flow and profit?
Profit (net income) represents the total earnings after all expenses, while cash flow reflects the actual movement of cash into and out of the business. Profit can appear healthy even as the business faces cash shortages due to delays in accounts receivable, high capital expenditures, or inventory buildup.
How does accounts receivable affect cash flow?
Accounts receivable is a factor that influences the company’s cash flow since it stands for the money that is owed to the company and not the money that is readily available. A higher amount of receivables can put the company in a position of having insufficient cash on hand, whereas quicker collections can bring about an increase in cash flow and working capital.
How do seasonal fluctuations impact cash flow?
Seasonal fluctuations can cause cash inflows and outflows to spike or dip unpredictably, challenging your ability to maintain sufficient working capital.
How can cash flow metrics help in securing funding?
Strong cash flow ratios prove that your business is financially healthy to investors and lenders, and create more credibility that will make loans more likely to be approved or investments to take place.
Stay on Top of Your Cash Flow with Cheqly
One of the major factors in the growth of a business is the effective management of cash flow, and Cheqly simplifies this task. By using Cheqly, you can view all the money coming in and going out of your business at any moment, categorize your expenses, and analyze your cash flow trends. With it, you can track payments, keep your budget under control, and have a clear view of your company’s liquid assets. Consequently, it becomes easier to make sound investment decisions, ensure that bills are paid punctually, and expand your business with confidence.
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