Posts Tagged ‘cash flow’

Free Cash Flow Versus Operating Cash Flow

I’ve been writing recently about cash flow, specifically in regards to important ratios to interpret it. The free cash flow to operating cash flow ratio is a useful measurement. Let’s see how it is calculated and what it means.

First Some Definitions

Generally free cash flow (abbreviates as FCF) is considered to be operating cash flow minus capital expenditures. (See Importance of Free Cash Flow)

Operating cash flow (OCF) is calculated as net income adjusted for non-cash charges and changes in current assets and liabilities. (See Operating Cash Flow Defined) In this calculation net income does not show the effect of interest and income taxes, so it is actually earnings before interest and income taxes (Abbreviated EBIT).

Calculating the Free Cash Flow to Operating Cash Flow Ratio

The formula for calculating the free cash flow to operating cash flow ratio, expressed as a percentage is: Read the rest of this entry »


Understanding the Operating Cash Flow to Sales Ratio

In my last posting I defined what operating cash flow is and how to calculate it. Now I want to see it in relation to sales.

Why in Relation to Sales

Since selling is the primary activity of a company for producing cash flow, the relationship of operating cash flow to sales is a meaningful one.

Operating Cash Flow to Sales Ratio Defined

To calculate the operating cash flow to sales ratio, which is expressed as a percentage, the following formula is used (where OCF stands for operating cash flow):

Operating Cash Flow to Sales Ratio = OCF / Sales Read the rest of this entry »


Operating Cash Flow Defined

Businesses often focus in on net income and fail to recognize the significance of cash flow (see Cash Flow – The Bottom Line) and what determines cash flow (see Cash Management-It’s Not About the Cash Account). Even when understanding the importance of cash flow and what generates it, there are some additional aspects to understand.

What is Operating Cash Flow

In a future blog I will show how the cash flow statement is created, but for now let’s just identify the three main components of the statement, which are: Read the rest of this entry »


The Cash Conversion Cycle

If you read my postings on a regular basis I may sound like a broken record with how much I focus on cash. But again, as I’ve said before, “Profit is nothing until it is converted to cash.” See Cash Flow – The Bottom Line. Now I want to delve into how efficiently we convert financial activity to cash.

Cash Conversion Cycle Formula

First we need to identify some abbreviations and definitions: Read the rest of this entry »


Importance of Free Cash Flow

In some previous posting I discussed how important it was to convert profits to cash. See Cash Flow – The Bottom Line for more on this. Now let’s look at cash from a different perspective.

Free Cash Flow Defined

Generally free cash flow is considered to be operating cash flow minus capital expenditures. This recognizes that capital spending for things like equipment is necessary if a company is to remain competitive. These capital expenditures help a company become more efficient or even allow them to Read the rest of this entry »


Debt Coverage

In the posting Why Debt Ratios Matter we looked briefly at what debt really is, one way of measuring it, and how the mix of debt and equity played a role in how appropriately a business was financed. Now let’s look at servicing debt, also known as debt coverage.

What Determines Debt Coverage?

Think about this from a personal perspective. Imagine you took out a loan to buy some furniture for your home, and it was one of those loans where you only paid interest for the first year. Starting in the second year you would be required to start Read the rest of this entry »


Accounts Payable Days Analysis

I’ve written extensively about how important cash is to a business. The accounts payable days analysis is an indicator of how well you are managing cash. This measure is also known as the days payable outstanding.

Are Your Vendors Happy?

We all know how important it is to keep customers happy. Don’t meet their needs or make them mad and they may leave you. Even worse, their comments may cause others to leave with them. Just like customers, you also need to keep vendors happy. If you don’t you may find your credit line cutoff and that you cannot get essential products and services. Imagine what happens when you cannot get the product you need to sell or use in your manufacturing process. Pretty soon it impacts your company’s ability to satisfy customers. The accounts payable days analysis is a statistic you can calculate that indicates how good of a job you are doing managing accounts payable and keeping your vendors happy.

The Calculation

The calculation is straight forward using the formula:

(Accounts Payable / COGS) * 365 where COGS is cost of goods sold.

Granted that the COGS does not include every expense that goes through accounts payable, but this is the basic formula. With that said, let’s look at an example of the accounts payable days analysis. If your accounts payable balance is $500,000 and your annual cost of goods sold is $2,000,000 the calculation is:

($500,000 / $2,000,000) * 365 = 91.25 days. This seems like a lot, but it is important to consider your industry’s average days for paying vendors. If the industry average is 120 days, then by comparison your company does not look that bad. On the other hand, if the industry average is 45 days then this is an indication you may be getting ready to experience difficulties with your vendors if you haven’t already. Of course the days payable outstanding is only one thing to consider. Your company may not have the financial clout of your competitors and vendors may keep you to a tighter leash. If so, you will need to earn their trust. Basically, managing accounts payable should be made a priority. Unfortunately, like the balance in the cash account, the issue is not with the accounts payable account itself. The balance in this account is the result of activity in other areas.

Some Causes and Solutions

Probably the three biggest causes of the accounts payable days analysis being too many days are the following:

  • Too much inventory or the wrong mix of inventory, thus having too many days of inventory supply
  • Too many days of accounts receivable outstanding, resulting in not realizing cash from sales in a timely manner
  • Gross profit margins are too low

I have discussed the issues with accounts receivable (See Accounts Receivable Days Outstanding Analysis) and inventory (See Inventory Days on Hand Analysis) to show the impact of not managing these diligently. In a future posting I will discuss the importance of adequate gross margin.

All that said, the quickest ways to get accounts payable under control is to address the accounts receivable days outstanding and the days of inventory on hand. With accounts receivable this involve your customer credit policies and staying on top of collections. With inventory you will need to analyze the balance on hand by item and see which items are overstocked. With both accounts receivable and inventory you can use the 80/20 rule to help you decide where to start. See the blog posting 80/20 Rule for Receivables Management for how this works with accounts receivable.

Next Steps

I encourage you to make the accounts payable days analysis to see just how well you are doing. AimCFO is here to help if you need it or are just not sure how to go about this process.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.


Improving Customer Payments

One of the biggest issues a business can face is past due customer accounts. Here are some ideas for improving customer payments to minimize the issue.

Deposits and Advanced Payments

If you are going to be spending significant amounts to complete something for a customer and it will take a while to complete, consider getting a customer deposit. Let’s say that you know the materials will cost $500 for something you will later bill for $1,000 to the customer. It will greatly improve your Read the rest of this entry »


Balanced Approach to Financial Management

I remember a partner in a small CPA firm telling a story from early in his career. He said he had been given the task of creating a balance sheet for a client. When it was in balance he declared, “It balances, so it must be correct.” Of course the balance sheet must balance, but he quickly learned there was a lot more to it than that.

Balance Does Matter

One of the first areas where a company often displays a lack of balance is on the importance of the different financial statements. The income statement shows the results of activities over a specific period of time, while the Read the rest of this entry »


Income Statement Snapshot

When you read your Income Statement (Profit and Loss Statement) what is your process? Do you just look to see if you made a profit? Try digging a little deeper.

The Big Picture

In the post Balance Sheet | A Different Look we took a look at how we first examine a balance sheet from an overall perspective, much like we look at a family photo. As this is done certain items will Read the rest of this entry »


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