To find the data for the formula above, you need your cash flow statement where you can get the cash flows from operations and the balance sheet where you can get the current liabilities.
Your operating cash flow ratio should be higher than 1.0. Otherwise, your company is in a serious financial trouble and may cease to operate. That means you are not generating sufficient cash to pay for your bills that gets your business to operate.
2. Cash Flow Margin Ratio helps determine the company’s ability to convert sales into cash and expresses the relationship between cash generated from operations and sales. The cash flow margin ratio formula is,
Cash flow from operating cash flows / Net sales = _____%
To find the data for the formula above, you need your cash flow statement where you can get the cash flow from operating cash flows and the income statement where you can get the net sales.
The higher percentage you get from the equation above indicates you have more cash generated from sales. In principle, if your cash flow is a negative number, you are losing money even if you are generating sales revenue. For your business to continue its operations, you will need to raise the money however possible such as through investors, lending, or bank loans to pay for your bills like your inventory and all other accounts payable relevant to your business operations.
3. Cash Flow from Operations / Average Total Liabilities helps you measure how solvent your company is that determines whether or not you can pay your debts and keep afloat. The cash flow from operations to average total liabilities ratio formula is,
Cash flow from Operations / Average Total Liabilities = _______%
To find the data for the formula above, you need your cash flow statement where you can get the cash flow from operations and the balance sheet where you can get the average total liabilities.
The higher percentage you get from the equation above is good indicator of your company’s financial flexibility. It also means your company has the ability to pay for its debts.
4. Current Ratio helps you measure how liquid your company is and tells you whether or not your current assets sufficiently covers your current debt. The current ratio formula is,
Current Ratio = Current Assets / Current Liabilities = ______X
To find the data for the formula above, you need the balance sheet where you can get the current assets and current liabilities.
The answer to the calculation above determines the number of times that your company can fulfill its short-term debts. Let’s insert some figures into the formula for better clarity such that if your company has current assets amounting to $200 and current liabilities at $100, the result gives you 2.00X which means that your company has the ability to pay the current liabilities from its current assets two times over. That’s a good figure placing your business in a good position because it can cover its debt obligations. If the result gives you 1.00X, it could suggest some financial problem and you should be working on improving your current assets value or reducing your current liabilities.
5. Quick Ratio (Acid-Test) is a liquidity test that excludes inventory. It helps determine your company’s ability to pay for short-term obligations with ready cash such as accounts payable, taxes, and wages. The quick ratio formula is,
Quick Ratio = Current Assets - Inventory / Current Liabilities
To find the data for the formula above, you need the balance sheet where you can get the figures for current assets, inventory and current liabilities. A quick ratio result of less than 1.0X suggests that your company has $1 of liquid assets available to pay each $1 of current liabilities, suggesting that you may need to sell inventory to pay for short-term debts. Higher the quick ratio suggests better financial position for your business.
What we learned from scientific journals is that a considerable number of literature found relevance of the cash flow ratios in predicting financial distress. A recent study by Fawzi, et al., (2015) affirms that “cash flow ratios are reliable tools to predict financial distress.
” Although the study focused on the Malayan context, it could well apply to global businesses.
Reversing Directions: Recovering from Financial Troubles
In an event that you miss to calculate financial troubles and find your business in a downward spin financially, recognizing your financial problems would be a good place to start.
The obvious culprit that sends you to a painful financial slump is your lack of cash flow. When you run out of cash, your business ceases to operate. But you should be able to detect multiple signals of financial distress from your financial statement. It will be wise to go back and analyze them. Identifying key indicators of financial problem could help you plot your course of action towards recovery.
You may think that during a financial crisis, it is unwise to get help. Wrong.
During a financial crisis, it is the perfect time to get help if you are determined to survive. Hiring a qualified financial advisor to help you is a necessary investment because the risks far outweigh the costs.
You will need your financial advisor's professional experience in developing a monthly operating plan with a detailed plot of your financial operations, which may include the following activities:
accounts receivable collection
accounts payable payment plan
operating expenses payment plan, and
any other financial obligations, such as bank debt payments
Another important factor is to manage your cash flow. Your operating costs should be analyzed for you to determine which items you can reduce or remove. Cutting your expenses can help improve your cash flow.
While there are many other steps you can take to fully recover from your financial problems, we focus our discussion on the initial you can take to shape your recovery plan. But we found this helpful diagram published in the Government Finance Officers Association of the United States and Canada
, which suggests three basic stages towards recovery from financial distress.
It may seem inapplicable to private business entities, but the framework provides the basic steps that will guide you to a successful reform and transformation.