Why Cash Flow KPIs Matter
When trying to figure out how your business is faring, having 100% cash visibility is critically important. Accurate cash flow forecasts provide vital insights, too. Several other quantifiable cash flow metrics, or key performance indicators (KPIs), can also help you gauge your cash picture, project your future standing, and improve your company’s overall financial health.
These cash flow KPIs can inform your strategies around liquidity, managing risk, and investing returns and identify areas of growth potential. Many can also help you see problems before they arise, so you can deal with them proactively.
How to Tell Which Cash Flow KPIs Are “Right” for Your Business
It’s important to note right off the bat that your treasury team can’t – and shouldn’t – track all the cash flow KPIs in existence. What you use will vary by the size of your company, what industry you’re in, and what your business objectives are. Plus, trying to track all financial metrics will bog you down in calculations and won’t leave you the time or energy to analyze and act on what these KPIs are telling you.
When deciding what KPIs to use, one approach is to determine where the treasury team could have the biggest impact and focus your efforts there. Another idea is to pick the KPIs that expose the biggest problem areas so you can deal with them as soon as possible. Whichever direction you choose, it can be extremely helpful to get buy-in on all the chosen KPIs from other stakeholders, such as executive leadership, shareholders, your board of directors, auditors, and others, so everyone is on the same page.
While it may take some trial and error to identify which KPIs are right for your organization, it’s well worth it in the end, as these can be essential tools for helping ensure your cash management efforts are trending in the right direction. It’s a good idea to periodically reassess if the KPIs you’ve chosen to measure provide you with the big picture you need, too.
10 Cash Flow KPIs to Consider Adding to Your Dashboard
Here’s a list of cash flow KPIs you might want to monitor to ensure your company is on course and slated to stay that way. We’ve also included calculations for each for easy reference.
Operating Cash Flow (OCF)
This key metric measures the cash generated from a company's business operations (excluding financing and investments). It helps a company see where it generates income and how it covers costs. The higher the OCF, the better, because that means the company is increasing capital without additional or external funding.
Financially healthy businesses also tend to see this KPI increase over time. Operating cash flow is known by other names, such as cash flow from operating activities, cash flow provided by operations, and free cash flow from operations. Calculate OCF with this formula, which may vary slightly per company:
Operating Cash Flow = Net Income + Non-Cash Items – Increase in Working Capital
Cash Flow Coverage Ratio
This ratio measures a business's ability to pay off its debts using its operating cash flow (OCF). It’s a key indicator of financial stability and frequently used by lenders and investors to understand how well a business can cover its bases, including interest payments.
To calculate it, a business must have a clear picture of its OCF and total debt. When the cash flow coverage ratio is high, the business is rated at a lower risk.
Here's the formula for the cash flow coverage ratio:
Cash Flow Coverage = Operating Cash Flow / Total Cash Outflows
Days Sales Outstanding (DSO)
DSO measures how long it takes a company to collect its accounts receivable after a sale. Looked at another way, it measures how long it takes for a business to convert sales made via credit to cash, which directly impacts liquidity.
If a company’s DSO is above 45 days (meaning it takes 45 days or more to collect payment post-sale), this would be considered high and would indicate the business has a lot of cash tied up and would be at increased risk for problems. A lower DSO, on the other hand, would mean a company maintains good cash flow and likely has good credit and collections processes in place.
The formula for DSO is:
Days Sales Outstanding = Accounts Receivable / Net Credit Sales x Number of Days in Accounting Period
Days Payable Outstanding (DPO)
DPO shows how long it takes a company to pay its suppliers and creditors. When a company maintains a higher DPO, it has more cash on hand for short-term investments or boosting working capital. But companies should strike a healthy balance and not maintain too high a DPO, or they can face issues with unhappy suppliers and see impacts on their creditworthiness.
It’s not uncommon for larger companies to have higher days payable outstanding since their buying power allows them to negotiate more favorable payment terms, so the business size can impact this metric.
Days payable outstanding is calculated with this formula:
Days Payable Outstanding = (Accounts Payable / Cost of Goods Sold) x x Number of Days in Accounting Period
Cash Conversion Cycle (CCC) (or cash flow conversion cycle)
CCC measures how many days it takes for a company to convert its inventory and accounts receivable into cash. Stated another way, this cash flow KPI measures how many days it takes to turn any of the company’s inventory purchases and other expenses back into cash by selling them. A lower CCC is usually preferred, as it would indicate the company has more liquidity.
You can get your cash conversion cycle with this formula:
Cash Conversion Cycle = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding
Free Cash Flow
Free cash flow shows how much cash is available after a company has met or paid for all its normal operations and obligations, such as debt payments and capital expenditures. The freer a business’s cash flow, the more flexibility the company has to allocate additional funds elsewhere where needed.
Here’s how to calculate your free cash flow:
Free Cash Flow = Cash from Operations – Capital Expenditures
Cash Flow Adequacy Ratio
This KPI helps a company determine whether it has enough cash to cover its ongoing expenses, which can include debts, capital expenditures, shareholder dividends, and operating expenses like rent, utilities, and salaries.
Generally speaking, a higher cash flow adequacy ratio (1.0 and higher) is better, showing the company maintains enough cash after expenses to avoid liquidity issues. The cash flow adequacy ratio provides a more thorough understanding of a company’s health than other metrics because it incorporates current and future cash flows.
To find this KPI, use this calculation:
Cash Flow Adequacy Ratio = Capital Expenditures + Debt Repayments + Dividends / Operating Cash Flow
Working Capital Ratio
This important KPI indicates how quickly a business can generate cash. It compares the business’s current assets that could be converted to cash in a year or less with its current liabilities. A working capital ratio over 1 is favorable.
To explain this ratio further, consider a company with a working capital ratio of 1.7. This would indicate the company has $1.70 in assets for every $1 in liabilities, meaning it can comfortably meet its current liabilities.
Calculate your working capital ratio with the formula below:
Working Capital Ratio = Current Assets / Current Liabilities
Cash Reserves in Days
This metric measures how many days a company could operate and keep paying its expenses if no new revenue comes in. Businesses with reserves of 90 days or more are considered better off. They would likely fare better if there were short-term disruptions, such as losing an important customer or needing to shut down due to an unforeseeable global or local event.
Get this KPI with this formula:
Cash Reserves in Days = Cash Reserves / Average Daily Expenses
Cash Flow Forecast Accuracy
Cash flow forecast accuracy measures how closely a business’s projected cash flow forecast, or their expected cash position in the future, aligns with the company’s actual cash movements. Accurate cash forecasts are critically important for businesses, as they allow them to avoid being short on cash and having too much cash in reserve.
This KPI enables a company to keep their forecasts as accurate as possible, which enables better decision-making. In general, companies should aim for a variance between projected and actual cash flow of 5% or less, meaning there was very little difference between what forecasts predicted would happen and what actually happened.
There are a couple ways to get this KPI, but here’s one of the main formulas:
Cash Flow Forecast Accuracy = 1 – ((Actual Cash Flow Forecast – Forecasted Cash Flow) / Actual Cash Flow)
Common Mistakes to Avoid with Your Cash Flow KPIs
Once you’ve selected the cash flow KPIs that match your objectives and are ready to start tracking them, it’s best not to rely entirely on spreadsheets to do so. Manually entering, tracking, tweaking, and calculating data can lead to errors. Plus, it can take so much time that your data becomes outdated, impacting the accuracy of your KPIs.
Your best bet is to upgrade to a treasury automation solution that integrates with all your banks and existing internal systems. This way, you can always have updated data to calculate KPIs and ensure you’re making the right day-to-day operational decisions and investment choices. Many treasury solutions can help you automatically track your important KPIs, too.
Secondly, don’t let a lack of resources or the need to work cross-departmentally stop you from acting on the intelligence these cash flow KPIs provide. You will have invested time and training to pull them together and will have a fair amount of actionable data at your fingertips once you’re tracking these KPIs more closely.
Ensure you take the right actions, whether that involves implementing changes right away or putting together an action plan to deal with necessary adjustments in the longer term. Managing your cash flow well is critical to keeping your business running, and these KPIs are a great barometer for knowing how you’re trending.
Don’t Skip Cash Flow KPIs for Actionable Insights
Effectively and efficiently handling your business’s cash flow ensures its success and longevity. Because of this, there’s a real need to track, analyze, and improve every aspect. By regularly using the appropriate cash flow KPIs for your business, you can help ensure you’re making the most informed cash decisions and supporting your long-term financial well-being.