This week, I’m following up on my last post.

Since I’ve already written at length about the strategic importance of good cash flow management and shared my top tips for maximizing it, I won’t rehash all that here.

Instead, I’ll be diving into the 7 cash metrics you absolutely need to be tracking to know where your business stands at all times.

That’s because from managing the financials of 45+ SMBs, here’s the #1 thing I’ve learned.

The most predictable way to kill your business is poor cash flow management.

In fact, U.S. Bank found that 82% of SMBs fail due to poor cash flow management. Yet it’s shocking how many businesses still rely on “bank balance accounting.”

Clearly, that’s not going to cut it.

Instead, here are the 7 critical cash KPIs that I’ve put together from helping 45+ SMB clients. My advice is to monitor and track each of these so carefully that you know exactly where you stand by heart, at any given time.

The 7 Cash KPIs You Need to Know

• Operating Cash Flow (OCF)

  Operating cash flow is an even better measure of your SMB’s health than net income. It tells you how much cash your business generates from core activities.

  Here’s how to calculate it.

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

  Note: Your non-cash expenses will include taxes, depreciation/amortization, etc.

  Some of the best ways to improve your OCF are to avoid paying suppliers early, collect outstanding receivables, increase inventory turnover or shorten the sales cycle, and cut unnecessary spending.

• Free Cash Flow (FCF)

  Free cash flow tells you how much cash your business has available to use. In other words, this is the excess cash not tied up in working capital or capex. It’s especially helpful to revisit this KPI when considering the purchase of assets or growing headcount.

  Here’s how to calculate it.

  FCF = Operating Cash Flow + Interest Income - Capex

  Note: Once you have your result, make sure that you also understand which liabilities are still outstanding and your timeframe for paying them.

• Days Payable Outstanding (DPO)

  Days payable outstanding is the number of days it takes the business to pay an existing invoice. Ideally, DPO should exceed DSO, which is covered below. That will allow you to collect cash before your bills come due and use the excess for investment.

  While increasing your DPO can improve cash flow if you’re looking to acquire assets, a higher DPO should be approached delicately as it could strain vendor relationships or signal a lack of cash available to pay unless you have strong credit.

  Bottom line, be intentional about increasing DPO and pay special attention to your most strategically important vendors.

  Here’s how to calculate it.

  DPO = Accounts Payable (A/P) / COGS in Period * # of Days in Period

  For reference, the average value for DPO sits between 30 and 40 days. But a company with favorable supplier agreements can be well above that. Besides negotiating with vendors, an easy way to bring up your DPO is to pay bills on time rather than early.

• Days Sales Outstanding (DSO)

  Days sales outstanding measures how quickly your business collects cash for every sale. It also helps estimate the size of your outstanding receivables. A longer DSO usually signals collection issues, especially if the explanation for it in your SMB extends beyond lax credit terms.

  Here’s how to calculate it.

  DSO = (Current A/R Balance / Sales in Period) * # of Days in Period

  To lower your DSO, here’s what I recommend.

  First is stricter credit approval. In other words, be intentional about the clients you sign on, focusing on their ability to pay on time. And if you have a sales team, you might want to offer the right incentives to get them on board and applying any applicable policies consistently.

  Second, update your payment terms. Aside from making sure that they’re clearly stated and consistent, consider offering early payment discounts, multiple payment methods, and electronic processing.

  Third, send out automated payment reminders as a supplement to your normal client communications.

  Fourth, set a positive tone for collecting your outstanding invoices, but be prepared to escalate as needed.

  Finally, make sure to send out invoices quickly and for the right amount.

• Overdue Ratio

  Similar to DSO, the overdue ratio is a measure of cash collection efficiency, and it gives you a quick percentage of what’s overdue relative to your total amount of open receivables. The reason it’s so critical is that it allows you to collect on accounts before they’re deemed unrecoverable and must be written off.

  Here’s how to calculate it.

  Overdue Ratio = Overdue Invoices / Total Amount of A/R

  As with decreasing your DSO, one of the best ways to lower your overdue ratio is to implement a consistent collection strategy that includes sending regular payment reminders, following up on outstanding invoices, and escalating as needed.

• Cash Reserves in Days

  Cash reserves in days tells you how many days the business would be able to survive without any new revenue.

  Maintaining a healthy cash reserve is how you plan for emergencies like COVID or a sharp downturn in the market.

  Here’s how to calculate it.

  Cash Reserves in Days = Cash on Hand / Average Daily Expenses

  For reference, you’ll want at least 30 days, but up to 90 days will allow for more time to respond in the event of an emergency or rapid changes in the market.

  Some of the best ways to increase your cash reserves are to maximize your cash flow—especially by collecting faster and paying later. For more on this, see last week’s post. In addition, I’d advise cutting unnecessary spending, and obtaining financing before you absolutely need it. A few ways to do this are covered here - link to twitter).

• Burn Rate

  Burn rate measures how fast your business is burning through its reserves. Keeping an eye on this one is absolutely critical for SMBs, early-stage businesses, and business continuity in the event of a severe market disruption such as COVID or a recession.

  Here’s how to calculate it.

  Burn Rate = Current Cash Balance / Monthly Operating Expenses

  Here’s how to slow down your burn rate.

  First, determine your run-out date. This will give you an added sense of urgency.

  Second, besides cutting unnecessary spending, try the following.

  • Collaborate with other businesses to share resources

  • Negotiate lower rent

  • Sell off unproductive assets

  • Tap into subsidies and grants

  • Borrow funds

  • Negotiate better payment terms

  • Identify alternate revenue streams

  • Close parts of the business that no longer make economic sense

Putting It All Together

Here are your top takeaways from this week’s post.

1. 82% of businesses fail due to poor cash flow management.

2. “Bank balance accounting” might be common, but it’s insufficient.

3. To stay on top of your cash flow, you need to know these 7 KPIs by heart.

   1. Operating Cash Flow (OCF)

   2. Free Cash Flow (FCF)

   3. Days Payable Outstanding (DPO)

   4. Days Sales Outstanding (DSO)

   5. Overdue Ratio

   6. Cash Reserves in Days

   7. Burn Rate

Hungry for More?

1. Follow me on Twitter and LinkedIn for daily content to take your business to the next level.

2. Shoot me an email with your questions or requests for what you’d like me to write about next.

‘Til Next Time,

Connor