29 October 2006

The Cash Management Gauge

The Cash Management gauge score depends on the current and past values for the following ratios:
Most of the data required to compute the ratios are drawn from the Balance Sheet, but some figures from the Income Statement and the Cash Flow Statement are also used.

The Cash Management gauge is determined by calculating a score for each of the eight items listed above.  A weighted average of the scores is scaled to set its minimum value at zero and its maximum value at 25 points.

We're tough graders: it's a rare company that will achieve a 25-point Cash Management score.

The scoring details are described below.  Please note there is an overriding zero-point floor and a five-point ceiling for each ratio.

Current Ratio

Score = 5 - 2.5 * (Current Ratio - 2.5) ^ 2

In our sample Balance Sheet, GCFR Corp. had a Current Ratio was 75/41 = 1.83.  It would earn 3.9 points.

The maximum score of 5 is attained when the Current Ratio = 2.5.  Points are deducted for higher Current Ratios, which might seem strange, because the company is building its bank account instead of putting its assets to work.

Score = 5.0 - 20*(LTD/Equity -0.2)^2

In our sample Balance Sheet, GCFR Corp. had an LTD-to-Equity ratio of 60/134 = 44.8 percent.  It would earn 3.8 points.

The maximum score of 5 is attained when Long Term Debt to Equity equals 20 percent.  The equation is constructed such that a company with an LTD/Equity ratio between 0 and 40 percent will get at least 4 out of the 5 possible points.  We think some debt is appropriate because it gives stockholders leverage, but we disapprove of excessive debt.


Score = (-1.5) * Debt/CFO + 5.25

Debt/CFO is measured in years.

A bonus point is awarded if Debt/CFO is lower that it was one year earlier.

In our sample Balance Sheet, GCFR Corp. had a Debt-to-CFO ratio of 16.6 months = 1.38 years.  It would earn 3.2 points.

Score = 25 * (delta Inventory-to-CGS / Inventory-to-CGS one year earlier)

Inventory-to-CGS is measured in days.

A 20 percent (i.e., 0.2) reduction in the number of Inventory days will achieve the full five points (25 * 0.2).

In our sample Balance Sheet, GCFR Corp. had a Inventory/CGS ratio = $13/0.433 = 30 days.  It the ratio was 33 days one-year earlier,  then the percent reduction would 3/33 = 0.091.  It would earn 2.8 points.

We don't use this ratio if inventory isn't significant for the company (e.g., the company sells a service, not a product).

Finished Goods/Inventory
Score = 200 * (decrease in the Finished Goods ratio from its median value)

If the current percentage of inventory made up of finished goods is above this ratio's median value, no points are earned.

A company gets the full 5 points if the current value of the finished good ratio is 2.5 or more percent less than its median value.

We don't use this ratio for scoring if the company's inventory doesn't consist of varying mix of raw materials, work in process, and finished goods (e.g., the company is a retailer), or if inventory isn't significant for the company (e.g., the company sells a service, not a product).

For example, let's say the finished goods component of inventory (the rest being raw materials and work in process) is now 28 percent and that the median value for this ratio is 30 percent.  The 2-percent reduction, worth 4 points, suggests that the company's sales were greater than expected.  The opposite, an increase in finished good inventory, is worrisome.

Days of Sales Outstanding

Score = 25 * (delta DSO / DSO one year earlier)

A 20 percent (i.e., 0.2) reduction in DSO is needed to earn the full five points (25 * 0.2). Lesser reductions will get lower scores. The score will be zero if there is no reduction.

For example, if GCFR Corp.'s Balance Sheet shows that Accounts Receivable averaged $12 million over the last year, and if its Revenue during the year was $200 million, then Receivables were 0.06 of annual Revenues, which is 21.9 days of Revenue.  If last year's figure was 23.9 days, then the score would be 25 * (2/23.9) = 2.1 points.

Working Capital/Revenue

Score =  ((-8.75) * WorkingCapToRevenue) + 3.5

Negative Working Capital results in a 3.5-point score.

1.5 bonus points are awarded if the ratio is lower that it was one year earlier.

The maximum score would be earned when Working Capital is negative and has become less as a percentage of Revenue.

In our sample Balance Sheet, GCFR Corp. had Working Capital of $75 million minus $41 million = $34 million on 30 June 2006.  During the previous year, the GCFR Income Statement lists Net Income of $20.1 million  Therefore, the Working Capital to Revenue ratio equals 34/20.1= 1.7, and no points would be awarded with the possible exception of the bonus 1.5 points.

Cash Conversion Cycle Time

Score = (1/2) * (percent decrease in CCCT from last year)

No score is allowed to be less than zero or greater than five.

In other words, each two percent decrease in CCCT earns another score point.

In our sample Balance Sheet, GCFR Corp. had a CCCT of 37 days.  If  this parameter had been 40 days one year earlier, then it decreased by 3/40 = .075 (7.5 percent).  This would earn 7.5/2 = 3.75 points.

Determining the Cash Management Score
We don't simply add up the scores described above to calculate the Cash Management score.  We believe some ratios are more significant than others.  To be specific, we use the following weights:

The Cash Management score is 5 * (the sum of each ratio's score multiplied by its weight) / (100, the total of the weights).

This post was last modified on 5 February 2010


  1. Hi,

    What do you suggest for replacement of Finished Goods / Total Inventory and Inventory / CGS ratios in service industry? Two problems - One, no concept of Inventory and two, associating a value to inventory is difficult.
    By the way in products company - where do you get Finished Goods in 10-K or 10-Q to compute the ratio?

  2. The Inventory ratios provide valuable insights into the operations of manufacturing companies, and we weight them highly. Unfortunately, as you noted, Inventory is not a meaningful parameter for other types of companies. This includes companies that provide a service and companies that sell intellectual property, such as software. We are not aware of a suitable analytical substitute for Inventory when assessing Service-providing companies. We, therefore, have to rely more on our other Cash Management metrics.

    For manufacturers, the breakout of Inventory of into its Raw Material, Work in Process, and Finished Goods components is provided either directly on the Balance Sheet or in a Note to the Financial Statements -- look for a note with a title similar to "Other Balance Sheet Data."