Metrics are a powerful tool for measuring progress, evaluating decisions, and when done right, are an early warning system for problems. There is one problem though… too many metrics cause indecision. You know; analysis paralysis.
What if there was one metric that could do it all? Well, I have good news and bad news. While there isn’t a single metric that can answer all your business questions, there is one that indicates your company’s core health. By measuring cash flow, you are measuring the blood flow of your business. And by tracking it through a metric called the Operating Cash Ratio (OCR), you will have your thumb on the company’s pulse.
This is how it works. First add up all the cash you currently have on hand. Add up the money sitting in the bank at this very moment (even if you wrote checks against it), the cash in your drawer, and the money sitting in your PayPal account. The only thing you don’t add in is the money in your PFA (Profit First Account). You do have a PFA right?
Let’s say you have a total of $7,576 in your bank accounts (checking, savings, payroll, etc.). And at your desk, you have petty cash of $37. And finally in your PayPal account you have $188. Add it up, and All Cash Currently On Hand is a total of $7,801.
Next add up all the money that is currently due (including any outstanding payments that haven’t cleared yet), in the next 60 days. This includes bills, rent, payroll and money you are taking for yourself.
Let’s say you have $950 in rent due this month (that is $1900 in 60 days), $737 in bills, $547 in part-timer payroll (next two months), and you are taking $7,000 in salary the next two months. That would result in All Money Due Within The 60 Days of $10,184.
Now divide Cash On Hand by Money Due to get the OCR. In this example you would divide $7,801 by $10,184. The resulting ratio is 0.77 (rounded).
And with that ratio you now have a guide to your company’s financial health. Here’s what the OCR means:
An OCR of 0 to 0.25 means your business is cash starved and financially unhealthy. Immediate action needs to take place to cut costs and increase cash on hand (more sales, better collections, etc.).
An OCR of 0.25 to 0.75 means your business is financially stable. No drastic measures are needed, but you should actively seek ways to increase cash flow (better sales, collections, etc.).
An OCR above .75 means your business is financially strong. Ironically this means you should take measures to protect yourself from attacks. For example lawyers love to “go after deep pockets”. So use this as an opportunity to put your money into capital investments or secure accounts.
By no means is the OCR the only metric you track, but it is the most important. Track it daily and you will not only know your pulse, but you will also be able to track trends. That’s a whole lot of power in one simple number.
By Mike Michalowicz, Author of The Toilet Paper Entrepreneur
