As a business owner, CEO, or someone who oversees finances, how do you know if your business’ cash flow is healthy? What’s normal vs. cause for concern? And what are the most helpful metrics you can use to evaluate--not only the current health of your business--but to also see if there’s trouble ahead. Here’s a quick list of the Top 5 business metrics for understanding the health of your company’s cash flow.
1. Review your Days Sales Outstanding (DSO)
You may hear people refer to this as Days Sales Outstanding, DSO, Time to Pay, Average Collection Period, or our personal favorite: Hey, have those guys paid us yet? This wonderful article from Investopedia is a great reference if you need a refresher on calculating your DSO. Since most B2B companies use 30-day payment terms, a DSO under 30 days is great to see. That’s like getting the 2% body fat reading. Even 30-40 days isn’t too much cause for concern. But once you start getting over 45 days, and definitely over 60 days (or 2x your net terms), it’s time to double-check your accounts receivable process. Are the invoices going out on time? Are you only sending out one notification at the point of sale and no reminders until it’s a week late? We’ve seen remarkable results from simply sending 3-4 reminders in those first 30 days. The follow-up doesn’t hurt the customer experience. If you need any help in this area, we have collection letter templates to choose from here and here.
2. Company savings account
The general advice is to have 3-6 months stored up in a business savings account. But that’s a really tough question to pair with a one-size-fits-all answer. Different industries, stages of companies, seasonality, this all impacts what the answer might be for your organization. Hal Shelton of Score.org does a good job in this article walking small business owners through which different factors to consider.
3. Compare accounts receivable (AR) to accounts payable (AP)
The American Express blog made a good point in one of their small business articles - It’s important to line up your payment terms with those of your suppliers to avoid any gaps. “If you're required to pay your suppliers within 30 days but you allow customers to pay within 45 or 60 days, you're creating a gap in cash flow. When considering how to improve cash flow in small business, that's an important area to focus on. Consider matching the supplier terms of payment to the customer terms of payment, if possible. What penalties do your suppliers charge for late payment? You might be able to do the same for your customers' late payments. Late payment charges may be an incentive for customers to pay on time, just as it's likely to be an incentive for you to pay your suppliers on time. ”If your AR is greater than your AP, you are going to struggle consistently with cash flow. You will spend a great deal on late fees, penalties and other forms. This is very important to match or have AR faster than AP
4. Accounts receivable report: Current vs. Past Due vs. Past Due > 60 days
When looking at the accounts receivable report, take a detailed look at the different buckets. An organization with more than 75% customers in the current column (not yet late) is in a different spot than an organization with 50% of their customers in the Past Due > 30 days or Past due > 60 days columns. Are there any trends of the late paying customers? Did you have a customer that used to pay on time, but has started to pay late over the past few months? Any specific industries? Are you enforcing late fees or utilizing a collections agency?
5. Taking a closer look at the cash flow statement
Within a cash flow statement there are three categories: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. Investopedia goes into great detail on how to navigate and evaluate these three areas, but one main thing to look out for: is your business relying too heavily on cash in exchange for equity. Is a low cash flow from your day-to-day operations causing you to give up too much ownership of the company? Another great metric is your Current Ratio. Simply your assets divided by your liabilities and gives you a good measure of your ability to pay for your short-term obligations. Though getting those two numbers can be a time consuming for some businesses, it’s very important to know if your Current Ratio is dropping below 1, meaning you don’t have the ability to meet your short-term obligations. Calculating the current ratio once could mean that the company can’t cover all of its current debts, but it doesn’t mean that the company won’t be able to cover those debts once the payments are received.
Bonus Tip: Have lunch with your sales team
Not a spreadsheet metric, but it’s a great idea to take out some of your sales reps for lunch at least once a quarter. Ask how things are going, see if there’s anything that might surprise you. For instance, some CEOs are surprised to learn their individual sales reps are tasked with chasing down overdue invoices. Other cash flow related things you might find out:
- Are prospects and customers frequently asking for 10% discounts?
- Has anyone tested out a Net 15 payment term?
- Has anyone quoted the price and the prospect said, “Oh wow, that’s less expensive than I thought.” Maybe you’re not charging enough!
