The Importance of Free Cash Flow

The Importance of Free Cash Flow

To discuss the importance of Free Cash Flow, within a business, I would first like to set the scene using the story of Joe Smith, CEO of Good Investments as an example. Joe Smith just received some financial statements from his Secretary showing 5 million dollars in revenue for the quarter. Upon the first review of these statements, he is feeling pretty good about the success of his company!

Now Joe wants to get going on his work day and sits down at his mahogany desk to pay some bills and calculate his quarterly taxes. First, he writes a check to his landlord for $10,000 then he pays the utility bills for $5,000. Next, comes all the company salaries at $1,985,000 and finally, he owes $3,000,000 in taxes. What is left of Good Investment's revenue? Nothing. Remember that good feeling Joe had a few moments ago looking at that 5 million dollar revenue figure - oddly it has vanished knowing he's simply broke even this quarter.

A better measure of Joe Smith's company performance would be its Free Cash Flow (FCF). FCF described at its most basic is how much money a company has left over after paying all of its bills. FCF is also a hard number to manipulate, making it a good indicator of company health. To calculate FCF you take the Net Cash Flow from Operations and subtract the Capital Expenditures and the number you are left with is FCF.

Free Cash Flow = Net Cash Flow from Operations - Capital Expenditures

Looking at FCF data over several years of a company's existence can identify if it is a healthy growing company or if it is doing poorly. FCF data that is trending up over multiple years indicates a company with growth earnings. The company is likely to be doing quite well and can expect to do well over the next year or so - reaping the reward of the staff's concerted efforts. A company whose FCF is trending down over the past couple years is witnessing declining earnings and needs to make some big changes if they want to bring their company back to a successful state.

As a small business owner paying regular attention to your company's FCF will help you understand the health of your company at its most basic. If you have a negative FCF it is time to review your expenses, find places to cut costs or boost your marketing efforts. If you have a positive FCF than maybe it is time to think of expanding or hiring additional staff or investing more in your company's future. Transworld recommends keeping the FCF in mind to help you, the business owner, stay in tune with your company's health and to help make solid decisions for its future!

For more information on how to best understand the financial health of your company and possible next steps to take to prepare your business for the future - including preparing your business for sale, schedule a consultation with one of our brokers today.

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Gary Goldwasser is a Business Intermediary with Transworld Business Advisors of Denver. Passionate about business, Gary believes, at its core, business is about trust and building strong relationships. His expertise comes from his years in printing sales, executive management and having owned three separate businesses himself. The experience and challenge of business ownership have directly impacted Gary and pushed him to be a great manager, co-worker, leader, husband, and father.