10 essential cash flow metrics every business should track

Mastering cash flow is crucial in business finance. By focusing on the 10 cash flow metrics every business should track, you'll gain insights to improve your company's financial health and support growth in 2024.

Operating cash flow (OCF)

Operating cash flow (OCF) reveals the cash generated from your core business activities. It reflects your company's ability to produce enough cash to maintain and expand operations without relying on external financing. According to NetSuite, OCF indicates how well your business can sustain its operations independently.

Formula

To calculate OCF, start with net income from your income statement, add back non-cash expenses like depreciation and amortization, and adjust for changes in working capital components such as accounts receivable, inventory, and accounts payable:

OCF = Net Income + Non-Cash Expenses + Change in Working Capital

Importance for assessing liquidity and operational efficiency

Keeping a close eye on OCF helps you gauge liquidity and operational efficiency—offering essential operating cash flow insights. A positive OCF means your business generates sufficient cash from operations to cover expenses, invest in growth, and manage debt service coverage—all from your own activities. Conversely, a negative OCF might signal potential cash flow challenges, indicating a need for additional financing to keep things running smoothly.

Regularly monitoring OCF enables you to:

• Assess financial vitality: Ensure your core operations are not just surviving but thriving sustainably.
• Assess investment opportunities: Determine if you have the funds on hand to expand or invest in new opportunities.
• Navigate debt strategically: Understand your capacity to meet debt obligations without seeking external assistance.

‍

Cash conversion cycle (CCC)

The cash conversion cycle (CCC) measures how swiftly your business transforms investments in inventory and accounts receivable into cash from sales. It highlights the efficiency of your cash flow management—balancing outflows to suppliers and inflows from customers.

Formula

The formula for the cash conversion cycle is:

CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO)

• Days inventory outstanding (DIO): The average number of days inventory stays in stock before being sold.
• Days sales outstanding (DSO): The average number of days it takes to collect payment after a sale.
• Days payable outstanding (DPO): The average number of days taken to pay suppliers.

‍

Significance in managing working capital and cash flow

Keeping tabs on your CCC shows how effectively you manage working capital. Implementing cash conversion cycle strategies can shorten your CCC, meaning you're converting resources into cash more rapidly, enhancing liquidity and reducing reliance on external financing.

Optimizing each component can boost your cash position and optimize net working capital:

• Reduce DIO: Minimize holding costs and mitigate the risk of obsolete inventory by moving stock faster.
• Lower DSO: Speed up cash inflows by improving your collections process.
• Optimize DPO: Retain cash longer before paying suppliers while maintaining strong vendor relationships.

‍

By regularly tracking the CCC, you can uncover opportunities to improve operational efficiency. Shortening the CCC frees up cash to meet obligations, invest in growth opportunities, or reduce debt—strengthening your financial stability.

Days sales outstanding (DSO)

Days sales outstanding (DSO) measures the average number of days it takes your company to collect payment after a sale. It's vital for understanding the efficiency of your credit and collection processes.

Definition of DSO

DSO indicates how quickly your business turns accounts receivable into cash. A lower DSO means faster cash collection, enhancing cash flow and reducing credit risk. A higher DSO might suggest delays in collections, impacting cash availability.

Formula for calculating DSO

The formula to calculate DSO is:

DSO = (Accounts Receivable ÷ Total Credit Sales) × Number of Days in Period

For example, if you have $100,000 in accounts receivable and $500,000 in credit sales over a 30-day period:

DSO = ($100,000 ÷ $500,000) × 30 = 6 days

Impact on cash flow and collection efficiency

Monitoring DSO helps you manage cash flow and assess the effectiveness of your credit policies and accounts receivable management. A lower DSO improves cash flow, enabling you to meet financial obligations and invest in growth opportunities. Efficient collections reduce the risk of bad debts and enhance working capital. A high DSO could signal issues with customer creditworthiness or collection inefficiencies, leading to cash shortages and increased financial risk.

By regularly tracking DSO and analyzing your accounts receivable turnover, you can identify trends and make informed decisions to optimize accounts receivable management.

Days payable outstanding (DPO)

Days payable outstanding (DPO) measures the average number of days your company takes to pay its suppliers. This metric offers insights into how you manage cash outflows and vendor relationships.

How to calculate DPO

The formula for calculating DPO is:

DPO = Average Accounts Payable / Cost of Goods Sold x Number of Days 

For example, if your company has an average accounts payable of $50,000, a cost of goods sold of $200,000, and operates over a 365-day year:

DPO = $50,000 / $200,000 x 365 = 91.25 days

Why DPO matters

Monitoring DPO helps you understand your cash management practices. A higher DPO means you retain cash longer, potentially improving liquidity. Delaying payments too much may strain supplier relationships and affect terms or supply continuity.

Balancing DPO is crucial. Optimizing DPO ensures you maintain strong supplier partnerships while effectively managing cash flow.

Cash flow margin

Cash flow margin measures how effectively you convert sales into cash. It represents the percentage of cash generated from operating activities relative to sales revenue.

Formula for calculating cash flow margin

To calculate cash flow margin, use the following formula:

Cash Flow Margin = (Operating Cash Flow ÷ Net Sales) × 100

• Operating cash flow is the cash generated from core business operations.
• Net sales are total revenue from sales minus any returns or discounts.

‍

Importance of cash flow margin in evaluating profitability and operational efficiency

Tracking cash flow margin is key for assessing profitability and efficiency. A higher margin indicates that a greater portion of sales is becoming cash, which can be reinvested, used to reduce debt, or distributed to shareholders.

By monitoring this metric, you can:

• Gauge financial health: Understand how well operations generate cash without external aid.
• Spot trends: Detect shifts in operational efficiency over time.
• Enhance cash management: Optimize processes to increase cash generation, such as boosting sales efficiency or trimming expenses.

‍

Regular analysis helps ensure your business remains financially robust and prepared for growth.

Forecast variance

Forecast variance measures the difference between projected and actual cash flow over a period. Understanding this variance is crucial for refining financial forecasts.

Formula

The formula for calculating forecast variance is:

Forecast Variance = Actual Cash Flow - Forecasted Cash Flow x 100

This calculation expresses the variance as a percentage, highlighting overestimation or underestimation.

Importance in financial planning

Monitoring forecast variance and learning how to create variance reports helps you improve forecasting accuracy. Regularly analyzing variances allows you to:

• Refine forecasting models: Adjust methods and assumptions where discrepancies occur.
• Make informed decisions: Reliable forecasts support better strategic planning.
• Mitigate risks: Anticipate cash flow fluctuations to prepare for potential shortfalls.

‍

Focusing on forecast variance helps you develop more reliable financial plans, strengthening your financial stability.

Free cash flow (FCF)

Free cash flow (FCF) is vital for assessing financial flexibility. It represents the cash remaining after covering operating expenses and capital expenditures—cash that's available for reinvestment, debt reduction, or shareholder returns.

Formula

To calculate FCF, subtract capital expenditures from operating cash flow:

FCF = operating cash flow – capital expenditures

Significance for assessing financial flexibility and investment opportunities

A higher FCF means more cash at your disposal to:

• Invest in growth: Fund new projects or expansions.
• Reduce debt: Pay down obligations to strengthen your balance sheet.
• Return value to shareholders: Offer dividends or buybacks.

‍

Monitoring FCF helps you understand your ability to generate excess cash and make strategic financial moves, especially when combined with tools like discounted cash flow analysis.

Current ratio

The current ratio measures your company's ability to meet short-term obligations with short-term assets. This ratio helps you assess liquidity risk and operational stability.

Definition

The current ratio compares current assets (convertible to cash within a year) to current liabilities (due within a year).

Formula

Current Ratio = Current Assets ÷ Current Liabilities

A current ratio greater than 1 indicates you have more current assets than current liabilities, suggesting good short-term financial health.

Role in assessing liquidity risk and operational stability

Monitoring the current ratio lets you understand your liquidity position and gain valuable liquidity management insights. A healthy ratio means you can cover short-term debts and keep operations running smoothly. A low ratio might signal potential liquidity problems.

An ideal current ratio varies by industry, but generally, a ratio between 1.5 and 3 is considered healthy. Tracking this metric and knowing how to calculate liquidity ratios helps you identify trends and address issues proactively.

Cash flow from operations

Cash flow from operations shows the total cash generated by your core activities over a period. It reflects money flowing in and out from regular operations, excluding financing and investing activities.

Understanding cash flow from operations is essential for assessing financial health. A positive cash flow indicates you can cover operating expenses and reinvest in the business without external funding. Negative cash flow might signal issues in managing receivables, payables, or operational efficiency.

By tracking this metric and knowing how to prepare a cash flow statement, you can:

• Evaluate business sustainability
• Identify cash generation trends
• Inform budgeting and resource allocation

‍

Regularly reviewing cash flow from operations ensures your core activities are financially sound.

Net cash flow

Net cash flow is the difference between cash inflows and outflows over a period. It provides a clear snapshot of liquidity, showing whether you generate enough cash to sustain operations and invest in growth.

A positive net cash flow means more cash coming in than going out—key for covering expenses, reducing debt, and seizing new opportunities. Negative net cash flow indicates outflows exceed inflows, which could lead to cash shortages.

Tracking net cash flow is crucial for assessing overall financial health. Regular monitoring helps you identify patterns, anticipate potential issues, and improve cash management strategies.

Take control of your cash flow with Ramp

By consistently monitoring these ten essential cash flow metrics, you gain deeper insights into your financial operations, optimize liquidity, and make informed decisions to support growth and stability. Whether you're managing a traditional business or focusing on e-commerce cash flow management, don't leave your financial future to chance—request a demo to see what we can do for you.