The GL Finance Corner: Cash Flow (Part 4)
There are several ways to measure cash flow. The most direct way is to check your bank account balance every day… but this surely isn't smart for strategically planning purposes.
You need an approach that works for you and your business, while telling you about your current situation and how it ties back into your long-range plan. Lastly, you need metrics that help mitigate liquidity and solvency risks.
Before you can measure, you need a plan to track.
One way to manage short-term liquidity risk is by creating and maintaining a 13-week cash flow model — every week. For more longer-term cash management, especially for seasonal or uneven cash flow businesses, developing a 12-month cash budget and incorporating an Actuals-to-Budget rigor is a smart move.
Before you can fix, you need a plan to measure.
One of our favorite metrics, or KPIs, of cash, is the Days Sales Outstanding ratio (DSO). Your DSO helps you measure your execution of underwriting, collections, and customer management strategy. There is nothing more powerful than watching your DSO shrink from 45 days to 30 days.
In other words, if you generate $1.2M in revenue and your DSO is 45 days, you are turning cash 8x per year. By simply reducing your DSO to 30 days, or turning cash 12x per year, your working capital will immediately improve by $50k. In other words, you could almost hire another 1–2 team members to help improve sales.
In terms of a historical story that shows how efficient you were with cash, we love the Indirect Cash Flow Statement. A cash efficient business has the potential to generate exponentially more value to the owners, yet, it is also one of the most difficult models to execute on in business.
