Cash flow is no doubt a vital part of any business especially small ones, but the accurate projections and forecasts of business are something which is needed to get the business moving.
A proper tracking of cash inflows and outflows and using the knowledge in taking corrective decisions is the primary way for a small business owner to ensure sustainable growth of the business.
In-depth knowledge and understanding of financial implications of a business growth plan are needed to accurately estimate funding requirements, to ensure operations are in sync with the growth, monitor progress and make necessary adjustments in real time.
Let’s look at the key 5 metrics which entrepreneurs should consider while making their projections:
1. PROFIT MARGIN = NET INCOME ÷ SALES
The profit margin ratio formula is calculated by dividing net income by net sales. A net sale is arrived at by subtracting any returns or refunds from gross sales. Net income equals total revenues minus total expenses. It’s usually the final number reported on a balance sheet.
Your firm’s profit margin indicated the money which is leftover after selling your products and services, expenses and investments. The total profit may change from product to product and should reflect the total amount of cost outlay, labor and a small percentage of overhead. In forecasting, the profit margin helps you anticipate the money which will be coming in the future.
2. CURRENT RATIO = CURRENT ASSETS ÷ CURRENT LIABILITIES
The current ratio is calculated by dividing your current assets by your current liabilities. Potential creditors use the current ratio to measure a company’s liquidity or ability to pay off short-term debts.
The current ratio indicates your status to clear off your short-term debts. The general notions suggest that higher the ratio, the better it is for the financial health of the company. It may also mean that you have a lot of cash. By tracking this ratio, you can derive the following conclusions:
- You can determine any potential capital emergencies in advance.
- In case of higher ratio, whether you can reinvest some capital in other parts of the business.
3. ASSET TO EQUITY = ASSETS ÷ SHAREHOLDERS’ EQUITY
The asset/equity ratio indicates the relationship between the total assets of the firm and the equity owned by shareholders (owner’s equity). This ratio indicated the leveraged company holds used to finance the firm.
Your asset to equity ratio reflects how your business is being financed. It could be either by loans or by positive cash flow. The higher the ratio, the more it is being financed by debt.
4. ASSET TURNOVER = SALES ÷ ASSETS
Asset turnover is a financial ratio which indicates how efficiently a company uses its assets in generating sales revenue for itself. Companies with low-profit margins tend to show high asset turnover while high profile margins lead to low asset turnover.
Your asset turnover ratio also measures how quickly you are making sales. If your capital is stuck in unsold inventory that means it can’t be invested in any other areas of business unless the goods get sold. The higher your asset turnover ratio, the better return you will receive on your money. A near-accurate estimation of how long your capital amount might be tied up in a certain inventory helps you witness a clear picture of your financial status so that you can plan your upcoming capital needs accordingly.
5. PAYABLES PERIOD = ACCOUNTS PAYABLE ÷ CREDIT PURCHASES PER DAY
Accounts payable turnover ratio is calculated by dividing average accounts payable by the cost of sales or total purchases made from suppliers.
Your payables period includes what you owe to third parties (vendor payments) and what your client owes to you (client invoices). Regular tracking of the amount due to come in and go out helps you have a better picture of business health and maintain a healthy cash balance.
A powerful cash flow metrics prove to be vital for the accurate estimation of cash flow projections and provide you with a sound understanding of the fundamentals of your business. By having the details of your cash flow on your fingertips on a timely basis, you can efficiently run your day-to-day operations and efficiently respond to new business opportunities.
Apart from creating a balanced cash flow, managing it is equally important for effective stewardship of your funds and avoiding potential obstacles in the future. You need to review the above listed five cash flow metrics with your internal team or outsourced controller services to determine which one best fits your business needs and your company’s operational style.