Free Cash Flow
Free cash flow is a measurement of a business's financial health and performance. Free cash flow is a measurement of available cash that can be distributed among investors or used for other business growth purposes. It is all the financial assets left after deduction of operating costs (wages, supplies, overhead) and purchasing assets (equipment, property, other major investments). A major player in business growth, the more free cash flow a company has, the more it can allocate to dividends, paying down debt, and growth opportunities. A healthy level of free cash flow is the ideal position that every entrepreneur wants to be in.
FREE CASH FLOW FORMULA
There are a few ways to calculate free cash flow. The most commonly used formula is:
Free cash flow = Operating Cash Flow (OCF) – Capital Expenditures
FREE CASH FLOW BENEFITS
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Growth and opportunities.
Free cash flow allows businesses to pursue growth opportunities such as investments, purchases, or the development of new products and services.
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Possibility for expansion.
It is a leverage if a company is looking for investments to expand. Without being able to demonstrate financial health via free cash flow, investors won’t be keen to invest in that company.
FREE CASH FLOW LIMITATIONS
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No forecast is a crystal ball.
Financial forecasts are simply well-educated guesses or assumptions. While they can be relied upon, there are always factors out of everyone’s control that could impede a company’s free cash flow.
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Free cash flow is best for short-term only.
Free cash flow is great for short-term projections and investments, but over the long run, there are too many variables. Recessions, advancements in technology, or bad reviews on a brand new product, can steer a company in a direction.
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It only works with complete transparency.
There can’t be anything left off the books or calculated incorrectly. Otherwise the final free cash flow calculations will be incorrect and that can land a lot of people in hot water.
FREE CASH FLOW VS. NET INCOME