Maintaining a healthy cash flow is crucial for business success and resilience. To improve business cash flow, entrepreneurs should understand its current state by tracking and measuring key cash flow KPIs.

Cash flow is simply the movement of money in and out of business. A financially healthy business typically has a positive cash flow, meaning more money is coming in than going out. However, measuring additional metrics beyond positive cash flow is essential to truly understanding the business's financial health.

There are many key performance indicators (KPIs) related to cash flow, and tracking them all can be overwhelming. By focusing on a select few KPIs, you can streamline your efforts and more effectively strategize to improve and maintain healthy cash flow.

Explore the different cash flow KPIs that truly matter for SMEs, and learn how to utilize them to improve your business cash flow.

Improving your cash flow and keeping it healthy is critical to business success - which is where cash flow KPIs come into play. Cash flow KPIs are specific financial indicators or metrics that help you evaluate the health of your business cash flow.

Unlike other KPIs that track, sales, customer experience, marketing, or process performance, cash flow KPIs measure the inflows and outflows of cash in your business to ensure your business is liquid enough to cover expenses.

Businesses gain accurate insights into areas needing improvement by measuring and tracking cash flow KPIs. This enables them to make more informed decisions about optimizing expenses, improving payment collection, and better managing cash reserves.

Additionally, financial institutions and investors use finance KPIs to assess the viability of lending or investing in a business.

Here are the top KPIs you should measure and track to improve business cash flow:

The quick ratio is a liquidity ratio that determines whether a company is liquid enough to meet its short-term obligations.

In business terms, liquidity means the ability of a company to convert its assets into cash.

Lenders or financial institutions use the quick ratio to measure financial fidelity or trustworthiness and decide whether a company should be approved for a loan.

A quick ratio of 1:1 indicates that the company has enough liquid assets to pay its current liabilities. The higher it is, the more capacity the business has to pay its short-term liquidity position.

Some of the ways you can improve your quick ratio are:

• Investing in short-term and highly liquid securities that can be easily converted to cash.
• Reduce current liabilities by negotiating with creditors to convert short-term obligations to long-term debts.

Days sales outstanding (DSO) is the average time your business gets paid after a sale.

Low DSO values show that your business collects its receivables quickly, obtaining more cash for your operations and growth. However, high DSOs indicate that the company waits a long time to collect its money, causing cash flow issues.

When comparing DSOs, only consider businesses along the same industry or business size, as every industry may have very different benchmarks.

A good DSO number generally falls below 45 days. This means that, on average, a company collects payments for its credit sales within 45 days. A rising DSO can indicate issues with credit management or collection processes.

The acceptable DSO number can vary significantly depending on the industry and specific business practices.

Larger, more complex businesses may have higher DSOs due to more intricate invoicing and payment processes. In addition, the terms offered to customers, such as 30- or 60-day terms, directly impact DSO.

Different industries have different DSOs. It's also important to compare your DSO to industry benchmarks and track it over time.

The key solution to reducing your DSO involves enhancing your payment collection process, which can be achieved through the following steps:

• Send invoices promptly after making a sale.
• Automate your invoicing system through accounting software to reduce errors.
• Implement late payment penalties to encourage customers to pay on time.

You can also watch this video to learn more about how to enhance your payment collection strategy and other tips for improving cash flow:

Days payable outstanding (DPO) measure the time it takes for the business to pay its suppliers or creditors. DPO also shows operational efficiency and resource use by SMEs.

High DPOs suggest that the business retains its cash longer, which is advantageous for SMEs when making short-term investments. However, excessively high DPO means the company delays payments too much, potentially straining supplier relationships or missing out on favorable credit terms.

Conversely, a low DPO could mean the company pays invoices too quickly. In this case, businesses do not utilize the suppliers' and creditors' payment terms, limiting their cash flow.

However, in some cases, businesses maintain low DPOs to maximize early payment discounts.

Businesses should find the most advantageous timing for making payments by:

• Negotiating longer payment terms without negatively impacting relationships.
• Evaluating whether early-payment discounts are more cost-effective than holding onto cash longer.
• Maintaining open communication regarding payment expectations and potential issues.

Days inventory outstanding (DIO) measures how many days it takes for a business to sell its inventory.

You don’t want your inventory to sit idly for long as a business owner. A low DIO simply means you’re able to sell your inventory quickly, leading to lower holding costs and improved business liquidity.

However, an excessively low DIO could suggest insufficient inventory to meet demand, leading to lost sales and customer dissatisfaction.

Meanwhile, a high DIO could mean your sales are slowing down, or you’re overstocking your goods. Slow-moving inventory negatively impacts your cash flow as it ties up your cash in these unsold goods and incurs additional storage costs.

A good DIO typically falls between 30 and 60 days. This means that, on average, inventory sits on the shelves for 30 to 60 days before it’s sold.

Different industries have different average DIOs. Industries whose products have short shelf lives or high demand volatility require lower DIOs.

In addition, lead times for replenishing inventory and transportation costs can influence the length of DIOs. However, insufficient inventory can result in lost sales and customer satisfaction, and excessive inventory can lead to higher carry costs.

Here are some strategies you can implement to improve your DIO and inventory management:

• Ensure your inventory levels match your business's current demand, which you can estimate through projections.
• Track inventory levels in real-time using inventory management tools to determine whether you still have enough stocks or need to buy more.
• Improve your sales strategies through promotions or targeted marketing to sell more inventory quickly.

Also known as the net operating cycle, the cash conversion cycle (CCC) shows how efficient a business is in turning cash into inventory and back into money, which involves the production or purchasing process, sales, and customer payments.

The shorter the CCC, the less time your cash is tied into inventory, allowing you to invest for growth.

In contrast, a longer CCC can lead to a negative cash flow, especially when your business takes so long to sell inventory or collect payments. You can learn more about negative cash flow and other aspects of cash flow management here:

By combining these three KPIs, the formula for CCC is:

Apart from the tips in improving DSO, DIO, and DPO, you can lower your CCC by:

• Making product delivery processes more efficient to collect payments earlier.
• Avoid overstocking goods beyond what is necessary for your sales demand.

Operating cash flow (OCF) represents the total money generated from a business's regular operations. This KPI is usually found in the first section of a cash flow statement and can either be positive or negative.

A positive or high OCF signifies that the company can cover its operational expenses and has the potential to reinvest in its growth. Meanwhile, a negative or low OCF means the business may struggle to sustain its current operations.

For businesses with low OCF, here are some steps to improve this KPI:

• Review your operations and cut unnecessary expenses, or look for cost-effective alternatives.
• Make invoice processing more efficient by offering multiple payment channels and providing incentives to early-paying clients.
• Boost sales through expanded marketing efforts or improving your current offerings.

While OCF only accounts for operational expenses (OpEx), which cover the day-to-day costs of running the business, free cash flow (FCF) considers both OpEx and capital expenditures (CapEx).

CapEx is an investment in long-term assets that support future growth and capacity, including equipment, property, vehicles, and technology upgrades. Meanwhile, OpEx is typically recurring costs relating to business operations, such as rent, utilities, and salaries.

FCF shows how much money is left over after settling short-term liabilities from business operations and spending on properties or equipment. A high or positive FCF means the business has enough surplus cash for debt repayments, dividend distribution, or growth reinvestment.

Improving your OCF also impacts your FCF positively. But apart from that, some tips for enhancing FCF are:

• Prioritizing capital expenditures is crucial for business operations, and postponing the non-essential ones.
• Consider leasing equipment or properties instead of purchasing to save on cash.

Creating cash flow projections or forecasts helps predict a company’s financial position in the future. Forecasts can predict cash shortages and surpluses and assist with scenario planning.

With forecast variance, businesses can assess the accuracy of their projections by showing the difference between the forecasted cash flow and the actual outcome.

A high variance indicates a need to reassess the forecasting process and identify significant cash flow changes to consider moving forward.

On the other hand, the lower the variance, the more reliable the business’s cash projections are, making them more useful for decision-making, such as preparing annual budgets.

Learn more about how you can prepare your annual budgets here:

Tracking forecast variance over time will significantly improve the accuracy of your projections. Here’s how you can lower forecast variance:

• Use accurate and updated data when making projections.
• Identify patterns, such as seasonal trends, to consider for your forecasts.

The sustainable growth rate (SGR) defines how fast a company can grow without additional debt or external funding.

A high SGR value signifies a combination of maximized sales efforts, a focus on high-margin products, and proper inventory management.

However, sustaining a high SGR over long periods is challenging. As a company grows, it may reach a point where profits and retained earnings are no longer enough to expand the business.

When growth stagnates due to these limitations, the company will need additional funding to keep growing. Businesses can decide to take on external funding from loans or investors or explore new product lines that can generate new revenue streams.

A high SGR means the company is well-positioned for self-funded growth. Here’s how you can achieve it:

• Evaluate and adjust pricing strategies to remain competitive and improve profit margins.
• Explore new markets and customer segments to boost sales growth.
• Use inventory management software to track inventory levels in real-time and avoid overstocking or understocking.

Just as humans depend on proper blood circulation for health, a business relies on efficient cash flow management to ensure its operations run smoothly. To achieve a healthy cash flow, businesses must use the right KPIs that accurately reflect cash flow efficiency.

However, measuring, tracking, and interpreting these KPIs require financial experts, like CFOs, who possess deep financial knowledge to translate these metrics into informed business decisions effectively.

Accessing the expertise of a CFO for your business is now within reach through OneCFO.

OneCFO is your trusted partner for growth, providing SMEs and startups with reliable CFO services at a fraction of the cost! With OneCFO, you can benefit from accurate and invaluable financial insights designed to optimize your cash flow and drive your business forward.

Visit us at onecfoph.co or email us at [email protected] to learn how our premiere fractional CFO services can help you avoid cash flow challenges.

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