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The cash flow conversion ratio is something that every business owner should know about. It's a simple calculation that can help you see where your business stands.
As a small business owner, you may not quite understand the cash-flow conversion ratio or how it can impact your business - and that's okay! The team at the BBB is here to help. Today, we will discuss the cash-flow conversion ratio and why it's so important.
Let's get started!
What exactly is the cash-flow conversion ratio?
According to a recent QuickBooks survey of over 3,500 small business owners, approximately 60% say that they've experienced cash-flow problems at some point and state that cash-flow issues are among their top three causes of stress.
This can be frustrating for business owners, especially when they have money coming in but can't seem to find a way to turn it into profits. The cash-flow conversion ratio is a simple way for business owners to determine the financial health of their business. It measures the amount of cash coming into the business compared to the amount of cash that is leaving the business each month.
By using the cash-flow conversion ratio, business owners can identify areas where they might be able to make adjustments to address cash-flow problems before they become too serious.
What is considered a good cash-flow conversion ratio?
A good cash-flow conversion ratio will vary from business to business. However, a general rule of thumb is that a ratio of 1:1 or higher is generally considered to be good.
When the ratio is lower than 1:1, this indicates that more cash is being taken out than being brought in. This means that your business is losing money. When the ratio is higher than 1:1, this indicates that more money is being taken in than is being spent. This means that your business is making money.
How do you calculate cash-flow conversion?
The cash-flow conversion ratio is calculated by dividing the amount of cash flow from operations completed by your net profits.
In other words, the cash-flow conversion ratio is calculated by dividing the amount of cash coming into the business through operations (such as sales) by the number of net profits.
It is important to note that the net profits number used in the calculation does not include any going towards expenses and other operating costs, such as inventory or marketing costs.
What impact does the cash-flow conversion ratio have on your business?
The cash-flow conversion ratio is an essential measure of your business's financial health. It can help you identify when your business is experiencing cash-flow problems. It can also help you identify the sources of cash that can be redirected to help your business overcome its cash-flow problems.
With a positive cash-flow conversion ratio, you can expect to generate enough cash to cover your business's day-to-day expenses. This will allow you to increase the size of your team or invest in new equipment and products.
On the other hand, a negative cash-flow conversion ratio means that you're losing money. This can be stressful for business owners, and it can also lead to more significant problems down the road if you don't take steps to address the issue quickly.
3 simple ways to improve your cash-flow conversion ratio
Most business owners understand the importance of a positive cash flow, but few know how to maximize their cash-flow conversion ratio. If you're experiencing cash-flow problems, here are three simple ways to improve your cash-flow conversion ratio:
1. Emphasize the importance of on-time payments from customers
One of the biggest causes of cash-flow problems is a lack of timely customer payments. If your customers aren't paying their invoices on time, this can cause a significant strain on your cash flow.
However, there are several things that you can do to minimize the impact of late payments, including placing a heavy emphasis on the importance of on-time payments. You can create a clause in your terms and conditions which states that all payments are due on the due date, and you can also send reminders to customers who delay making payments.
2. Improve your inventory turnover
One of the biggest drains on your cash flow is having too much inventory. The longer your inventory is on the shelf, the more money you will lose in terms of lost sales and inventory costs.
This can be accomplished by reducing your inventory levels and ensuring that the products on the shelf are moving. You can also use your sales data to identify which products are generating the most sales, which can help you re-focus your efforts on those products.
3. Pay careful attention to your invoices
One of the most overlooked cash flow sources in most businesses is the invoicing process. By creating a system where you're sending invoices and following up with customers on a timely basis, you can significantly improve the cash flow generated from your invoices.
Keep growing with more from the BBB
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For more excellent tips on running a successful business, check out the BBB business news feed and the BizHQ.
BBB of Southern Piedmont and Western N.C. contributed to this article.