What it means
Totals tell you what happened; rates tell you how quickly it is happening now. Saying a business generated $1,080,000 of cash last year is useful, but saying it generates $90,000 a month or 12 cents of cash for every dollar of revenue is what lets you plan next month, compare against a competitor and spot a change in direction.
The term covers several related measures. The most common are the operating cash flow margin (operating cash flow as a percentage of revenue), the monthly net cash flow rate, and the burn rate, which is the same idea expressed as a rate of consumption for a business that is spending more than it earns.
Rates matter because they normalise. A $200,000 improvement in cash means something quite different for a $2,000,000 business than for a $50,000,000 one, and expressing cash flow as a percentage of revenue lets you compare years, divisions and competitors on the same footing.
The practical use is mostly in early warning and in runway. If the monthly cash flow rate turns negative and stays negative, dividing the available cash by that rate gives the number of months before the account is empty, which is the single most important number for any business under pressure.
Rates are also the natural language for targets. Asking a team to improve the operating cash flow margin by two percentage points is clearer and more durable than asking for an extra $180,000, because the rate target keeps its meaning as the business grows.
An important nuance is choosing the right denominator and period. A rate calculated over a single month in a seasonal business is close to meaningless, so most analysts use a trailing three or twelve month average and state clearly whether the figure is before or after capital expenditure.
In practice
Real-world examples.
Example
A software start-up reports a burn rate of $140,000 per month against $1,680,000 of cash in the bank. The founders describe their position as twelve months of runway, which sets the timetable for the next funding round.
Example
A hotel group tracks its operating cash flow margin monthly and sees it fall from 21% to 14% across a single season. Investigation shows agency staffing costs, not occupancy, as the cause.
Example
A distribution business uses a daily cash flow rate of $12,000 to sense-check whether a proposed $250,000 stock purchase can be absorbed without touching the overdraft. It splits the order across three weeks instead.
Think of it
“Cash flow rate is the pace of cash flow-how much cash you generate per period or activity.
Formula
Calculation
Operating cash flow margin = operating cash flow / revenue, and the periodic cash flow rate = operating cash flow / number of periods.
A specialist tooling business generates operating cash flow of $1,080,000 on revenue of $9,000,000 for the year. Its operating cash flow margin is $1,080,000 / $9,000,000 = 0.12, or 12%, meaning every dollar of sales converts into twelve cents of operating cash. Expressed as a speed, the monthly rate is $1,080,000 / 12 = $90,000 per month, and on a 360 day convention the daily rate is $1,080,000 / 360 = $3,000 per day. If a competitor of the same size reports a 7% margin, the tooling business is converting sales into cash roughly 70% more efficiently.Case study
Seen in the real world.
The following is illustrative and Northgate Analytics is an invented company. The board reviewed only annual cash totals and believed the business was steadily improving, since cash generated rose from $600,000 to $720,000 in a year.
When the finance team recalculated as a rate, the picture reversed. Revenue had grown from $5,000,000 to $8,000,000, so the operating cash flow margin had actually fallen from 12% to 9%, and the monthly rate in the final quarter had dropped to $40,000 against $70,000 a year earlier.
In this fictional case the totals hid a deteriorating trend that the rates exposed immediately. Northgate added the monthly cash flow rate and the twelve month margin to the front page of its board pack.
Watch out
Common mistakes.
- Calculating a monthly rate from one month in a seasonal business, which produces a number that flatters or alarms for no real reason.
- Comparing a cash flow rate before capital expenditure with a competitor's rate after it, so the two figures are not measuring the same thing.
- Confusing the cash flow rate with the profit margin, when non-cash charges and working capital movements make them diverge substantially.
Questions
People also ask.
What is a good operating cash flow margin?
It varies widely by sector, though for many established businesses a range of roughly 10% to 20% is a reasonable place to start.
How is burn rate different from cash flow rate?
Burn rate is simply a negative cash flow rate, describing consumption per month rather than generation.
Should I use gross or net figures?
Always use net cash movement for the period, because gross receipts alone tell you nothing about how fast money is leaving.
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