Journey of a Serial Entrepreneur

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How to get from where you are to where you want to be

Financial Metric #1: Net Cash Flow

“Performance stands out like a ton of diamonds. Non performance can always be explained away.” Harold S. Geneen

Last week I dedicated an entire series to better management of business cash flows. This is a critical function and holds the key to success for many companies. When I evaluate the health of a company, this is probably the first financial indicator that I look up. I have learnt through experiences that one can have a fantastic business model, be earning a nice profit providing a product/service, but if the business is plagued with recurrent liquidity problems I am wary about making an investment into the venture. Net cash flows is simply calculated by subtracting your cash inflows from your outflows. When looking at this metric there are a couple of things to look for:

1. Cash Inflow Trends: This provides data regarding how cash inflows have progressed over the historic period under evaluation. Is there a stable growth of inflows over time? Are the inflows cyclical in nature? How long does it take for an order to be converted into a cash inflow? What one is looking for is substantial evidence regarding the viability of growth and stability of cash streams of the business .

2. Cash Outflow Trends: At what percentage do cash outflows grow with an increase in cash inflows? Does the business experience diminishing returns after a certain inflow threshold has been reached? Are outflows cyclical in nature or is there a fixed outlay? If a business has a high fixed cash outflow without the support of growing inflows, there is bound to be a substantial cash glut at some point. Also, if inflows are slow to be realized into cash and there are long periods where net cash flow is negative, this does not reflect well on the business sustainability.

3. Overall Historic Trends: Equating both the inflow and outflow streams we get a good overall picture of the net cash flow situation over a certain period of time. This will show how resilient the business is in recessionary periods and how it conserves and invests cash during boom periods. If managed well we should see a positive net cash flow situation that will be a good representation of the overall health of the business. 

A business which is constantly plagued with cash flow gaps will have a challenging time expanding the business. Such a business must re-evaluate it’s current business model and re-analyze it’s inflow and outflow trends. Through this analysis one should be able to arrive at pain points in the current model such as “excessively long payment cycles,” and find ways to resolve this issue by tweaking operational procedures and overall business strategy. 

Related Posts:

- 5 Tips for Better Cash Flows

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One Response

  1. [...] 1. Net Cash Flow: This is by far one of the most important metrics, and one has to continuously keep an eye on it. Net cash flow is simply calculated by subtracting cash inflows with outflows. Alternatively, it can also be calculated by adding depreciation and other non cash expenses to net profit. Without adequate liquidity a business is often unable to reach its potential and will suffer severe growth issues. Use this metric to monitor the liquidity health of your business and analyze trends in areas beginning to run low on reserves. To learn more about how to calculate and use the net cash flow metric please click here. [...]

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