May 19, 2023
Building a Winning Cash Culture
Creating a strong cash culture starts with people. It involves effectively communicating the value of cash in creating sustainable growth and resilience during uncertain times. In a cash-focused culture, all members of the organization, from the CFO to department managers and staff, share ownership of cash management. Meaningful discussions about cash should take place routinely in leadership and board meetings, with clearly defined responsibilities and accountabilities. Contract payment terms need to be reviewed and keep customer terms short net 30 days or less and extend payments to vendors to net 60 or more where possible. Implementing well-defined processes for cash forecasting, metrics, and key performance indicators (KPIs) is crucial.
The Power of a 13-Week Cash Flow Forecast
A 13-week cash flow forecast is the gold standard, particularly in times of uncertainty and recession. However, it also provides enhanced clarity during prosperous times, leading to better decision-making for core business operations and expansion initiatives. This forecast enables businesses to anticipate liquidity challenges, make modifications to their plans, and identify potential trouble ahead. Building and managing a cash forecast properly involves understanding the reasons for variances between actual cash and forecasted cash. Investigating and addressing changes in cash inflows or outflows is vital to maintaining financial stability.
Cash Flow Metrics and KPIs
In addition to the 13-week forecast, several cash flow metrics and KPIs should be considered. These indicators measure performance against established goals, while metrics provide specific insights into cash activity performance. Selecting the most relevant metrics and KPIs for your company, aligned with short and long-term cash goals, is essential.
Operating cash flow (OCF) vs Free cash flow (FCF)
FCF is a more comprehensive measure of a company's cash generation because it includes all cash inflows and outflows, while OCF only includes cash generated from operations. If you have negative FCF you will need to monitor your burn rate. Cash burn rate is the negative free cash flow during the month or period you are measuring and is used when calculating your cash runway — the number of months until cash runs out. Knowing what your runway is and finding ways to extend it are essential in uncertain times.
Accounts receivable metrics
Days sales outstanding (DSO) measures the average number of days it takes a business to receive payment for goods and services purchased. If you see a trend in your DSO increasing this is an indication that customers are delaying paying you and can result in cash flow issues. Accounts receivable turnover (ART) is used to measure how effective you are at collecting on AR from customers. An aged AR analysis report is also useful in helping identifying credit risks which can impact cash flows. Essential to best practices in AR management includes extending your view to your customers. They are facing and navigating the same uncertainties which may result in delays to invoice payments and increase to DSO. Strengthening relationships with key customers can provide early indicators about impacts to cash flow.
Other Ratios
Working capital ratio measures the liquidity of the business and indicates the ability to meet obligations as they come due. Cash flow coverage ratio (CFCR) is a measure of a company's ability to cover its cash flow obligations. It is calculated as cash flow from operations divided by cash flow obligations. Businesses with inventory will need to know their cash conversion cycle (CCC). CCC is a metric that shows the amount of time it takes a company to convert its investments in inventory to cash.
Cash Dashboard
One cannot measure everything, and too much data becomes confusing so be selective in what you have on your dashboard. When determining what KPIs and or metrics to put on your dashboard, make sure you are aligning with short and long-term goals for cash. Be specific about which indicators and measurements will help you assess the historical heath of the business (lagging) and which provide the view forward (leading). Most KPIs will be lagging so one needs to compliment these with leading analysis. An example of a leading indicator would be incorporating pipeline data and metrics to your cash evaluation. Knowing your pipeline conversion metrics provides valuable insight to bookings, revenue and ultimately cash collections. Early signs of pipeline declines will provide time to plan for ultimate negative impact to cash.
Take Action
Changes in your forecast or the metrics you measure are a call to action. When performing your analysis include qualitative data along with the quantitative measurements. The story or the why is as important to know as the numbers.
Here are some important questions to ask to gain insights:
- How much decline in cash inflows can you tolerate?
- What actions can you take to offset the decline?
- Why is a change occurring?
- Are customers changing pay habits?
- Has profit margin eroded?
- Have expenses increased?
Each question requires investigating the root cause to understand the why behind the changes. Once identified, appropriate actions can be taken to remedy or mitigate the situation.
Navigating Uncertainty with a Cash-Focused Culture
In an era of volatility, uncertainty, complexity, and ambiguity (VUCA), businesses must embrace a cash-focused culture to thrive. Rising inflation, supply chain disruptions, talent wars, and geopolitical tensions have introduced unprecedented uncertainty. Those who prioritize cash planning, measure variances, ask the right questions, understand the story behind the data, and take corrective actions will emerge as survivors in these challenging times.
Business success starts and ends with cash and liquidity. Are you prepared to win in this VUCA environment?
