How to Evaluate your Cash Flow Health
Measuring cash flow should is always tied to business goals and operational needs. Every company has different needs, so indicators in cash flow statements vary accordingly.
Some approaches may prove more effective than others. This post will discuss ways to measure your cash flow health, from macro analysis to practical indicators to help you create actionable solutions.
How Do You Analyze Cash Flow Health?
We'll start with the indicators we recommend for a macro-level analysis.
Cash Flow On A Macro Level
Looking at sales numbers is a great first step. You can spot if sales are dropping, growing, or behaving erratically. Don't just look at monthly or quarterly sales; look at your compound annual growth rates. An excellent place to start is by asking these questions:
- Is the growth rate healthy?
- Is the company hemorrhaging cash?
- Can the company manage this growth?
Revenue Per Full-Time Employee
This metric provides excellent insight into your company's operations for actionable solutions.
By evaluating how your company operates, you can find where employees spend more time than necessary due to lacking the right tools and resources.
- What this doesn't mean: It's time to let go of employees that aren't pulling their weight.
- What this means: Look for ways to make your employees more efficient. Automating repetitive tasks allows them to focus on analysis and leverage to increase revenue and improve your bottom line
It would be best to have a goalpost while analyzing this metric. Start by benchmarking your average revenue per FTE, then design tests to move the needle up or down. Think outside the box for new approaches to reach higher productivity.
But remember, you're benchmarking against yourself for trends, not looking at competitors.
This metric takes a similar approach to sales: you should look for ups or downs. For some companies, gross margins are telltale of their financial health. But this metric is often the hardest to manage as it involves many factors.
But managing this number is challenging if you can't get it under control. Take special care of your margins. If tight, you must focus on containing costs and improving operational efficiency and unit economics.
This metric is a strong indicator of your business's success. Like with previous metrics, we must track patterns and behaviors with a slight negative variation. But keep these limits in mind:
- Positive profit doesn't mean your cash flow management is in good health.
- A negative profit doesn't mean your company has no cash on hand.
To get the big picture, piece all the metrics together.
How Do You Analyze The Cash Flow Statement? (In-Depth)
Once you've completed the macro-level analysis, start your in-depth analysis. It will give actionable items to improve your company's cash flow health.
Stable Cash Flow From Operating Activities (CFO)
Start by keeping track of your cash flow from operating activities over some time. If it's steady over the years, then it's a good sign. Look at the core business if the line's erratic with significant spikes and dips.
Here are some key things to ask:
- Is your product or service failing to compete in the current market?
- Is your salesforce performance unpredictable?
- Is your overhead increasing?
Cash Flow From Operating Activities/Sales Ratio (CFO/Sales)
Next, look at the cash flow trend from operating activities divided by sales. You want to see CFO (Cash Flow Operations) increase while your CFO/sales ratio remains stable. If CFO is rising, but CFO/sales ratio is declining, look closely at your cost of goods and general expenses.
Managing Debt Using Cash Flow From Financing
It's all about keeping a balance:
- If you have surplus cash, paying off debt faster is good. Reducing debt helps create a cushion.
- Avoid using all your extra money to repay debts if you're sacrificing growth.
CFF To CFO Ratio
This one is easy. Never have too much CFF (Cash Flow from Financing) and insufficient CFO.
Here's a simple way to look at it:
- It's a good sign if your cash flow continues to grow while CFO declines.
- It's a bad sign if you're taking on many expenses while relying on borrowed funds.
Free Cash Flow (FCF)
We use FCF to measure the net amount of money available in the company. You want this metric to be trending upward sustainably.
Ending Cash Available
The final thing to analyze is available cash. A best practice is having at least three months of cash as a cushion to cover mandatory payments regardless of your business's income.
As mentioned before, it's all about keeping the balance. Some experts might say that too much parked cash could be better used employing it to drive business growth. Evaluate how to manage the need for an on-hand cash cushion in case of eventualities without blocking your company's growth.
To Sum Up
A high-level analysis can help you see where financial problems may arise in your company. It's a perfect tool for decision-making if you complement it with actionable solutions that can be worked on using an in-depth analysis.
Luckily, financial teams now have digital tools to create quick reports in real time. AR automation tools such as Paystand are an excellent ally for tracking expenses for strategic decision processes. Book a demo with one of our AR experts today if you want to know how Paystand can help your AR team create accurate and fast reports.