Free cash flow (FCF), also called net cash flow, is the current amount left over after a business pays its expenses and other capital expenses (including rent or equipment leases), resulting in an overall net amount of money that is still available for usage. This is an important financial statement tool for evaluating a business’s ability to make money. For most businesses, a positive FCF means a successful operation that has resulted in plenty of money left over for the investors and staff. Conversely, a negative FCF suggests that the business is on the path toward bankruptcy and the owners are not capable of providing the kind of support to the business that is needed to keep it afloat.
To calculate free cash flow, first you must know what all the components are. They generally include Accounts Receivable, Accounts Payable, Cost of Goods Sold, Cost of Service, Inventory, Cost of Revenue, and Net Earnings. You can’t expect to accurately calculate this amount without the other components. If you have access to some type of finance data such as inventory cost estimates, purchase order financing, or capital expenditures proposals, you will be able to calculate this more easily. Typically, however, most business owners cannot obtain this type of information.
When calculating free cash flow, the focus should be on the future earnings potential of the business. This indicates a focus on growth opportunities. The best way to identify possible growth opportunities is to look at the business’s past history. Over time, a business tends to experience certain patterns. By identifying these trends, you can determine which products and/or services are best sellers, and which may be the next best thing.
Obviously, the goal of any business is to make as much money as possible. Therefore, the free cash flow statement reflects this goal. It is important to have good management practices in place so that excess funds are never run up. In addition, there should always be enough money tied up in assets (including machinery and property) to cover the necessary short-term cash needs of the business. In order to be prepared for unexpected events, businesses should have a liquid cash balance, meaning they have enough liquid assets to cover their activities without generating too much interest debt.
A free cash flow statement is only useful as a guide, not as a guarantee of profits. To determine whether a business will earn profits, it is necessary to obtain separate reports that indicate the operating profit margin, sales revenue, and other factors. A better measure of profit would be the gross profit margin, as this includes a calculation of the difference between total revenue paid to the expenses, and the gross profit.
The free cash flow is calculated by subtracting the expenses from income before income, before deducting investment earnings. After expenses, it adds another column called interest income, to adjust for the effect of interest payments on the gross revenue. This final column, called net income, represents the positive or negative free cash flow effect. As you can see, the analysis is very complex, involving a number of complex numbers. However, the purpose is simple: it gives an investor’s a snapshot of the current balance sheet, including a comparison to the previous period.
The main factor, most people focus on when calculating free cash flow is interest payments. Interest income and expense are usually calculated as a percentage of overall gross revenue. However, there are some special cases where these two factors can change, such as when the borrower receives a loan with higher than usual interest rates. Calculating the effect of interest payments changes slightly because the payment amount is not necessarily figured into the equation. Instead, the lender uses a different formula to calculate this figure, known as the capital gain formula.
Another possible way to calculate free flow is by using the earnings per share or CPA statement per share method. This is complicated and much depends on the type of business being analyzed, so it’s best to use one of the more advanced calculators that have been developed for this purpose. Generally, however, CPA statements are easier to understand and calculate, offering better measure of free-flowingness. There is another method, known as the dividend yield to ownership method, which may be a better measure of free-flowingness if the dividends are reinvested in the company.