Do You Know What Your Cash Flow Ratio Should Be – Tip Of The Month

In previous articles we have talked about your targets for Salaries and Interest Expense as a percentage of Gross Sales and Inventory Turns. In this month's tip we will look at how to calculate your Cash Flow or Working Capital Ratio. Read how

We have talked about how your company's cash flow is the life blood of your business. Not enough and you will struggle each month paying your bills, buying inventory and even making salaries on time. Too much cash flow and you are not effectively utilizing the working capital in your company to generate more profit.

The most critical shortfall in cash flow comes when you have sold a number of financed units and the auditor shows up for a floor check and you cannot payout your sold product. This is the fastest way I know of closing down a business, because the finance companies do not have the luxury of negotiating long term work out scenarios.

Your cash flow ratio can be a little tricky because it varies dramatically depending on the industry. For example, if we were looking at the food business where the inventory and receivables are turned rapidly, we would expect a higher ratio. However in the Marine and Motorsports industry, inventory turns at a much slower rate therefore the ratio should be lower.

To calculate your cash flow ratio we must first calculate your working capital, which is simply, current assets minus current liabilities. We then divide your gross annual sales by your working capital which provides us with a cash flow ratio. Whether your ratio calculates at 5:1 or 16:1 has very little meaning without a base to compare it to.

Statistics show that the most profitable dealers are operating at a ratio of between 6:1 and 10:1. Armed with this information now calculate your ratio and see where your company's working capital or cash flow ratio is operating.

The higher the ratio the more difficulty you are having meeting your monthly obligations. Simply put, if you have a ratio for example, of 16:1 you probably do not have adequate working capital to service the volume of sales for the company as it compares to the industry. This may mean you should consider a further investment to support the cash availability in the company or a long term loan that can supplement your cash flow needs.

Now that you know your cash flow ratio based on your yearend financial statements you should go that extra step and prepare a monthly cash flow projection sheet. This will target your peaks and valleys for your cash flow throughout the year. By calculating your cash flow ratio you now have a good feel for your company's position, but that is only a guideline to the needs of your business. A cash flow projection with give you a dollar value requirement during the slow periods of your fiscal year and whether you need to address any short fall based on your working capital during those periods.

Still not sure what your cash flow ratio means to your company? Give me a call and we will get you on track. Contact me

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