How Much of the Cash You Have, Is Yours?
Cash is a critical measure in any business. But how much of the cash your company has, is actually yours? Unless you properly account for advance customer payments, the answer is unclear.
Just as Best Buy is not allowed (by law) to recognize revenue when they take payment for a gift card, you should not count customer payments for future work as income. Until the work has been performed, and any portion of the payment can be applied to a customer invoice for that work, the unapplied payment should be classified as a Customer Deposit Liability.
One of our VITAL Signs is Deposit Coverage - cash plus inventory, divided by the "unearned" deposits you have on hand. E.g., a cash balance of $65,000, with inventory of $205,000 and $150,000 of customer deposits, yields a coverage ratio of $270,000/$150,000, or 1.8. That's OK, though a coverage ratio of 2+ should be a minimum goal. A ratio of 3 or higher generally indicates a solid financial condition.
On the other hand, if you are recognizing revenue as payments are received, you cannot see "work owed" on your balance sheet. And not all integration companies maintain an inventory asset, either. Without both of these key measures, the "how much is yours" answer is decidedly unclear.
Steve Firszt and Paul Starkey have formed the quintessential business metrics firm in VITAL Management. Their quantitative model along with group comparatives and personalized coaching form a unique professional service for the custom electronics industry. Working exclusively with companies of $2M in sales or more, VITAL Management is helping good companies become great.