Give yourself leeway by keeping an eye on KPIs – Daily Business Magazine
CASH FLOW ADVICE: Craig Alexander Rattray asserts that key performance indicators (KPIs) and ratios provide a guide to liquidity
The most important key performance indicator (KPI) is the cash balance and obviously the higher the better. Likewise, the KPI that calculates the level of free cash margin is also important. This KPI can be used when a company has an overdraft facility and indicates the amount of cash it expects beyond the limit of the facility.
For example, if the cash flow is £ 20,000 and the overdraft facility is £ 100,000, the margin of safety is £ 120,000.
Most cash flow ratios are related to financial statements and accounts. They compare the company’s cash flow with other categories of financial statements and accounts. Clearly, a higher level of cash flow provides business owners with greater security and confidence, and provides an indication of the company’s ability to experience declining transactions.
These ratios focus on liquidity and may provide a better indication of the financial position than the profitability of the business.
Some of these ratios include:
- Cash Flow Coverage Ratio: Calculated as operating cash flow (cash flow from trading) divided by total debt. The goal is to have a high cash flow coverage ratio because it indicates that a business has enough cash flow to pay the scheduled principal and interest payments on any debt. The cash flow coverage ratio measures a company’s creditworthiness and demonstrates the company’s ability to use its operating cash flow to repay debt.
- Cash flow margin ratio: calculated as cash flow from operations divided by sales. This is a more reliable measure than net income because it gives a clear picture of the amount of cash generated per pound / dollar of sales. This takes into account the cash flow schedules.
- Current liability coverage ratio: calculated as cash flow from operations divided by current liabilities. If this ratio is less than 1: 1, a business is not generating enough cash to pay its immediate obligations (mainly trade / creditors debts) and therefore may have difficulty making these payments on time. If it is less than 1: 1, it is generally regarded as an indicator of potential insolvency or at least of cash flow problems.
While these ratios are interesting and can provide insight into the trading and cash position of the business, for most owner-managed businesses the focus should be on cash position and leeway. .
Treasury advice appears here every Thursday
Extract of Mastering Cash Flow for Business Owners by Craig Alexander Rattray and Jeff Borschowa, available on Amazon, priced at £ 6.95
Craig writes a column for Daily Business every other Monday
Craig Alexander Rattray
CR Enterprise Solutions