Income and Cash Flow are two very different things. You can have a million dollar business, and still be unable to pay the bills. There are several contributing factors to this problem, so I am going to go over two Key Indicators that you can track to help you know and understand your business better.
The first Key Indicator to keep an eye on is Accounts Receivable turnover. Good Cash Flow means people are paying us, which is different than sales; often sales are computed based on the invoices sent out. Cash Flow requires that we not only sell something but that we also invoice them and then get paid. This is also an indicator of how good your company is at collecting the money your customers owe you.
To figure A/R turnover, you only need two figures, the amount of sales in the period and the average Accounts Receivable during that same period. Getting the average is quite simple: take the Accounts Receivable at the beginning of the period and at the end of the period, add them together then divide by the number of days in the period. Take that number and divide it into the sales for the period and you have the turnover rate. The higher the resulting number, the better you are doing at turning invoices into cash for your company.
The second Key Indicator to look at is the Accounts Payable turnover – this is how effective you are at paying your bills that you pay over time instead of as you need it. For most small businesses this would be those items that you receive today, but don’t pay for until 30 days later. It also indicates if you are effectively using credit in your business. You will need to know the amount of expenses purchased on credit (this is not a credit card but can include the portion of the credit card you pay each month). For example, if a jewelry maker goes to the bead store and picks up 100 new colors of beads but they won’t pay the vendor until the next month, they have purchased this on credit without using a credit card.
Next you need the average Accounts Payable, which is calculated the same way as the accounts receivable average. Then divide the annual credit purchases by the Accounts Payable average and you’ll have the turnover rate. Again, the higher the resulting number, the better you are at paying your bills on time.
So what do these two Key Indicators tell you? Together they tell you if you have enough cash coming in to pay the bills on time. If both numbers are increasing the money is coming in fast enough to pay your bills on time. If one number goes down while the other goes up, it can be signaling problems are on the way.
We now offer strategic analysis service which includes analyzing both of these Key Indicators. This will allow you to track on a monthly or quarterly basis how your business is doing so you can correct one or both issues before the trouble shows up in your checkbook register. Call or e-mail us today to set up an appointment to see what Key Indicators you should be tracking in your business.