The 6 Best Metrics and Financial Statements for Your Cash Flow Forecast

Cash is always king for businesses. Here are the most important cash flow statements and metrics you can use to manage your small to mid–sized company’s working capital.

Invoice payment periods have increased by almost a day on average year-over-year for 1,240 global financial decision-makers, according to C2FO’s 2022 Working Capital Survey. Additionally, almost a quarter of businesses said that a lack of access to funding negatively impacted their business in the last year — and 30% of those companies cited poor cash flow as the biggest barrier to securing financing.

Longer payment timelines often cause cash flow problems, which create obstacles to business sustainability and growth. Fortunately, you can anticipate and adapt to cash shortages by monitoring cash flow metrics.

Consider using the following metrics and financial statements to track and forecast the amount of money flowing in and out of your business so you can maintain the working capital needed to operate and grow.

1. Operating cash flow statement

A cash flow statement includes cash flow related to operations, assets and investments. Of the three, the most important metric to monitor is your operating cash flow.

This shows you the cash flow from your core business activities. Because it doesn’t include investment activities or loans, it is a more reliable indicator of your business’s sustainability. The operating cash flow ratio indicates whether you are making enough money from your operations to pay your bills.

Your operating cash flow ratio is determined by dividing cash flows related to your operations by your current liabilities. Your current liabilities include debts due within a year — such as accounts payable, bank overdrafts and short-term debts.

Aim for an operating cash flow ratio of 1.0 as a minimum. This ensures that you have the cash to cover short-term debts.

2. Cash ratio

A cash ratio measures your business’s liquidity and its ability to pay off short-term debts. This metric is often used by lenders to determine how much financing you are eligible for. Rather than dividing your operating cash flows by your liabilities, a cash ratio divides your cash and cash equivalents by your liabilities.

Cash and cash equivalents include legal tender, checks, bank drafts and any asset that can be converted into cash quickly (within 90 days). By using only your cash holdings, a cash ratio gives you the most conservative liquidity measurement.

If your cash ratio equals 1.0, you have just the right amount to pay off your current liabilities should your business fold. However, if the ratio stays below 1.0 over time, this could mean that your business is struggling to stay profitable.

If your ratio is more than 1.0, it’s possible that your business isn’t maximizing cash on hand for business growth and smart investments. Alternatively, it could indicate that you’re saving a buffer for anticipated shortages.

3. Cash conversion cycle

Rising inflation rates mean that businesses are coping with higher commodity prices and longer customer payment terms. Monitoring your cash conversion cycle (CCC) is crucial for navigating inflationary periods. A CCC measures how long it takes your business to turn inventory and other investments into cash flow from sales.

If your business has a longer cash conversion cycle, it may have higher inventory costs, wait longer for customer payments, have insufficient working capital and struggle to pay bills on time. A CCC combines three metrics:

• Days inventory outstanding (DIO) — the number of days, on average, it takes for your inventory to turn over.

• Days sales outstanding (DSO) — the number of days, on average, it takes to collect your receivables.

• Days payable outstanding (DPO) — the number of days, on average, it takes you to pay your vendors and suppliers.

You can calculate your CCC by subtracting DPO from your combined DIO and DSO. The lower your CCC, the better. A low CCC indicates that your inventory sells quickly and your customers pay their invoices sooner rather than later. This gives you the working capital needed to pay your vendors on time and invest in inventory before prices rise again.

To reach a lower CCC, aim for a shorter DIO and DSO and a longer DPO. Early payment programs are an easy and cost-effective way to minimize your DSO.

4. Balance sheet

A balance sheet gives you a financial snapshot of your company’s assets (current and long-term), liabilities (short- and long-term) and shareholder’s equity (common stock, retained earnings and current income) at a point in time. In other words, it shows how much shareholders have invested as well as what your business owns and owes.

A balance sheet represents the financial health of your business, which is useful information for shareholders. You can also use it to calculate financial ratios.

A balance sheet has two sections — your assets in one, and your shareholders’ equity and liabilities in the other. When you’re creating a balance sheet, list items in order of liquidity, starting with cash. Your total assets should be well-balanced by your liabilities and shareholder equity, with the ideal equation of:

5. Gross profit

Gross profit is the money your business earns after subtracting the cost of sales and production. This doesn’t cover indirect sales costs, such as administrative fees or the money spent marketing your product or service.

Measuring your gross profit allows you to evaluate your business’s profitability. This cash metric can help you reconsider the resources you use to create your product or service. For example, a low gross profit may necessitate making your production processes more efficient or using cheaper materials. Gross profit is an important measure during inflationary periods when supply costs increase.

You can calculate your gross profit by subtracting the cost of goods sold (COGS) from your revenue. COGS include direct goods costs, such as factory overhead, labor and materials. Your revenue includes the money made from a sale before any deductions. Gross profit is measured for a specific period.

6. Available working capital

Your available working capital includes the immediate cash you have to cover short-term expenses and invest in growth opportunities. It also indicates how much flexibility you have to cover emergencies or withstand market changes like inflation.

Monitor your available working capital to ensure you have enough cash to meet short-term obligations and address potential cash flow issues. This metric is also valuable if you want to fund business growth. Even if your new investments require more funds than you have on hand, a healthy amount of working capital will improve your financing eligibility.

Calculate your available working capital by subtracting your current liabilities (again, debts due within a year such as accounts payable and bank overdrafts) from your current assets (cash and other assets that can be quickly converted into cash).

The bottom line

Before the COVID-19 pandemic, monitoring metrics like your cash conversion cycle might have seemed unnecessary. Now that inflation is rising and customer payment periods are increasing, your small to mid–sized business can no longer afford to overlook cash flow and working capital metrics.

While it may seem daunting at first, tracking your cash ratio, CCC and other working capital metrics will help you plan for growth and address cash flow shortages proactively. If accounting isn’t your strong suit, hire an accountant to advise on the best cash metrics to include in your cash flow forecast, and review these numbers at least once a month.

Want to see how your business stacks up against current working capital trends and issues? Explore C2FO’s new working capital survey.

This article has been updated, and originally published on June 16, 2021.