5 Key Financial Metrics to Avoid Running Out of Cash

Managing cash flow is a critical aspect of running a successful business. A positive cash flow ensures you have enough funds to cover your expenses, invest in growth opportunities, and maintain a healthy financial position.

To avoid running out of cash, it is essential to track specific financial metrics that would provide insights into your business’s financial health. 

In this blog post, we will discuss five critical financial metrics that every business owner should monitor to avoid cash flow problems.

1. Day Sales Outstanding (DSO)

Day Sales Outstanding (DSO) is a measure of the average number of days it takes for a company to collect payment after a sale has been made. A high DSO indicates that a company is taking longer to collect payments from its customers, which can lead to cash flow issues.

To calculate DSO, divide your accounts receivable by your total sales and then multiply the result by the number of days in the period.

To improve your DSO, consider implementing strategies such as offering discounts for early payments, tightening credit policies, and regularly following up with customers to ensure prompt payment. Monitoring your DSO can help you identify potential cash flow problems and take corrective action before they become critical.

2. Debt-to-Equity Ratio

The Debt-to-Equity Ratio is a measure of a company’s financial leverage, indicating the proportion of debt used to finance the business compared to its equity. A high Debt-to-Equity Ratio suggests that a company has a higher amount of debt relative to its equity, which can be risky and lead to cash flow issues if the business is unable to repay its debts.

To calculate the Debt-to-Equity Ratio, divide your total liabilities by your total equity. A lower ratio is generally considered better, as it indicates a lower reliance on debt to finance the business. 

To reduce your Debt-to-Equity Ratio, consider paying off debts, increasing equity through investments, or improving your profitability.

3. Current Ratio

The Current Ratio is a liquidity metric that indicates a company’s ability to cover its short-term liabilities with its short-term assets. A ratio of 1 or higher suggests that the company has enough assets to cover its liabilities, while a ratio below 1 indicates potential cash flow problems.

To calculate the Current Ratio, divide your current assets (cash, accounts receivable, inventory) by your current liabilities (accounts payable, short-term debt).

To improve your Current Ratio, consider increasing your cash reserves, speeding up collections of accounts receivable, or negotiating better payment terms with suppliers.

4. Quick Ratio

The Quick Ratio, also known as the Acid-Test Ratio, is a more stringent liquidity measure than the Current Ratio. It excludes inventory from the calculation, as inventory may not be easily converted into cash. A Quick Ratio of 1 or higher indicates that a company can cover its short-term liabilities without relying on the sale of inventory.

To calculate the Quick Ratio, divide your current assets (excluding inventory) by your current liabilities.

To improve your Quick Ratio, focus on increasing cash reserves, speeding up collections of accounts receivable, and reducing inventory levels.

5. Operating Cash Flow Ratio

The Operating Cash Flow Ratio is a measure of a company’s ability to cover its current liabilities with the cash generated from its core business operations. A ratio of 1 or higher indicates that the company is generating enough cash flow to cover its liabilities, while a ratio below 1 suggests potential cash flow problems.

To calculate the Operating Cash Flow Ratio, divide your operating cash flow by your current liabilities.

To improve your Operating Cash Flow Ratio, focus on increasing your profitability, reducing operating expenses, and improving your working capital management.

Final Thoughts

Monitoring these five financial metrics can help you keep a close eye on your business’s cash flow and ensure its financial health. By regularly reviewing and taking action on these metrics, you can identify potential cash flow problems early on and avoid running out of cash.

If you need help learning more about these financial metrics, work with us at Ash CPA! With our CPA and bookkeeping services, you can rest assured that your business will complete all measures to avoid running out of cash! Message us today to schedule a consultation!