Main Reason Businesses Fail
According to the Small Business Administration, the number one reason for most business failures is a lack of capital or funding. To ensure business success, every business owner needs to understand the role cash plays in their business. As a financial advisor, educating clients about the key cash metrics is crucial to help them make prudent financial decisions and succeed in the long run.
Top Three Cash Monitoring Metrics
Cash flow, net cash flow, and cash conversion cycle are the top three cash monitoring metrics. Cash flow is the money moving in and out of a business. Net cash flow is the difference between cash inflows and outflows in a period, and the cash conversion cycle measures the time it takes for a business’s investments to become sales and revenue.
Cash Flow
Cash Flow is the money that is moving (or flowing) both in and out of your business. It affects your liquidity and shows you the exact amount of funds you have available at any given time. The cash flowing into your business comes from your customers and clients buying your products or services, while the cash flowing out of your business is payments for expenses. The Net Cash Flow is the difference between a company’s cash inflows and outflows in any particular period. It is a crucial financial indicator of a company’s core operations and can help investors gauge its functions and see whether the core operations generate ample money in the business.
Net Cash Flow
Net cash flow is a crucial financial metric that reflects a company’s cash inflows and outflows in a specific period. It is not the same as net income, free cash flow, or EBITDA. Net cash flow is made up of three forms of activities that reflect a company’s core operations, financing, and investment activities.
Operating activities are the basic cash inflows and outflows from the company’s core business operations. Cash receipts from customers and expenditures for goods sold, administrative expenses, and other operating expenses fall under this category. Understanding the cash flow from your core operations helps you make better decisions about your business’s day-to-day cash management and forecasting.
- Financing activities represent the cash inflows and outflows from debt agreements, repurchasing company shares, paying off debt, and paying dividends. Understanding your financing activities helps you track your cash flow for long-term planning, capital structure, and managing your company’s liquidity and solvency.
- Investment activities reflect the cash inflows and outflows from investments, including fixed assets and investment instruments. Understanding investment activities helps you assess your business’s growth potential, evaluate the return on investment, and manage the risk and liquidity of your investments.
- Net cash flow is a critical financial indicator for any business, as it reflects the company’s liquidity and financial health. A positive net cash flow indicates a company has more cash inflows than outflows, while a negative net cash flow indicates the opposite. By understanding your company’s net cash flow, you can identify areas for improvement, optimize your cash flow management, and make informed decisions about financing and investments.
Cash Conversion Cycle
The Cash Conversion Cycle, also known as the Net Operating Cycle, measures the time it takes for a business’s investments to become sales and then into revenue. This metric accounts for the time it takes to move inventory, get paid, and pay debts without incurring additional fees or interest. The formula to calculate the Cash Conversion Cycle is CCC = DIO + DSO – DPO, where DIO is the days of inventory outstanding, DSO is the days of sales outstanding, and DPO is the days payable outstanding. The Cash Conversion Cycle is crucial to understand as it indicates the company’s efficiency in managing its important working capital assets and provides a clear view of a company’s ability to pay off its current liabilities.
How to Calculate Net Cash Flow
To calculate the net cash flow, you can use the following formula:
Net Cash Flow = Net Income + Gains & Losses from financing & investments + Non-cash charges + changes in operating accounts
The “changes in operating accounts” refer to changes in accounts such as accounts receivable, accounts payable, and inventory. These changes can significantly impact a company’s net cash flow, as they affect the company’s cash inflows and outflows.
Final Thoughts
Analyzing these metrics and keeping track of them through monthly cash flow reports is crucial to understanding a business’s financial situation accurately. Net cash flow is essential for a company’s expansion, development of new products, or debt reduction, making it the most crucial financial indicator. The cash conversion cycle is essential to gauge a company’s efficiency in managing its working capital assets and paying off its current liabilities.
In conclusion, understanding these key cash metrics is vital for business success. Every business owner needs to monitor their cash flow, net cash flow, and cash conversion cycle to make informed financial decisions and ensure their business’s long-term financial gain.
When your clients understand these metrics and how cash plays into their long-term success, the sky is the limit for financial gain.