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How to Calculate Free Cash Flow for your Business Health

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Free cash flow is one of the key indicators used to show the health of the business, particularly its profitability. Typically, it demonstrates the amount of money any business for other purposes after all the capital expenditures that may include equipment, buildings and various other necessary expenses that help businesses sustain their operations.

Although calculating cash flow is a complicated process, there are many ways you can do it. According to experts, it is always better to use all methods correctly. If they all generate the same result, it provides you a reliable way to cross-check your operations.

It is worth noting here that cash flow doesn’t relate to all businesses. It is precisely a measuring tool that non-financial firms use rather than professional associations and investment firms.  If you own a non-financial enterprise, you can calculate the cash flow for free with these three equations.

Equations to Calculate Free Cash Flow

1.       Free Cash flow:  Subtract operation taxes and costs from Sales revenues then subtract required investments for operation capital

The equation is one of the easiest ways to calculate free cash flow. Business owners take sales revenues, including taxes and operating costs from their income statement. The fixed assets show an increase when you invest in new operating capita. The balance sheet shows everything from investments and revenue details.

For example, if your business has earned revenues of $500,000, the amount is reduced to $300,000 because of taxes due and operating costs. If your business requires an investment of $150, 000, it will have the free cash flow of $30,000 to $50, 000.

2.      Free Cash flow:  Subtract net investments in operating capital from net operating profits NOPAT (after taxes)

 NOPAT refers to the same figure we used in the previous equation: subtract operating taxes and costs from sales revenues. Net investment of operating capital uses the same figure that is used in the third term of first calculations. For calculating free cash flow through this equation, it is better to use the increased fixed assets on your balance sheet.

That means, your NOPAT will remain at the same amount of $30,000. You just need to exchange the required investment of your business in operating capital for your net investments in operating capital.  If you assume the same figures, your free cash flow will remain the same.

3.      Free Cash flow:  Subtract capital expenditure from the net cash flow of operations

 You can also calculate free cash flow by subtracting the capital expenditure from the net cash flow that comes from operations.  Net cash flow in this equation comes from the cash flow statement, while capital expenditure is taken from the increase in the business’s fixed assets.  For instance, if your operation’s net cash flow is around $200,000, the figure might be reduced by your capital expenditures.

Interestingly, all these free cash flow calculation methods will give you the same answers when you work with these equations. You might feel like approaching the same information and data from three different angles.

How does Free Cash Flow Calculation Affect Your Business?

As mentioned earlier, free cash flow is useful for the health of your business. Firms with healthy free cash flow are financially stable to meet the bills and investments every month. Plus, they also have leftover funds that they usually distribute among dividends and shareholders. Man firms use this extra fund to seize opportunities to help them generate more revenues through acquisitions of innovative products.

That is to say, if your business is booming and has high free cash flow, it is an indication that it is doing well and you should consider expanding it. Conversely, if it fails to generate good free cash flow, you might need to consider restructuring it as there are remaining funds after the basic expenses.

However, it is important to understand that poor free cash flow doesn’t always indicate a failing business. It might be expected even when your business is pursuing growth. Development and acquisition of new products are temporarily subtracted from the main capital. That is the reason why most of the investors tend to work with the businesses that have high free cash flow. These businesses are generally considered healthy with bright prospects. If an investor finds a business that has rising free cash flow with an undervalued share cost, it may be a great investment bet.

How can you Benefit from the Free Cash Flow

Since you understand how positive free cash flow may benefit you by indicating the healthy financial status of your business, it is better to use this understanding to your advantage. It is always better to look beyond the figures. Know that established firms have relatively consistent and healthy free cash flow. New businesses, on the other hand, are in a state where they need to pour money into growth and stabilization.

Although it depends on the business owners how they use the free cash flow, using the funds to expand the operations, pay shareholders and dividends, invest in new products, research or to reduce debt is beneficial for the business.

Always remember that companies that have surging free cash flow due to debt elimination, dividend distributions, cost reductions, efficiency improvements, or revenue growth can reward their investors in the future.

In other scenarios, when free cash flow is shrinking, businesses fail to sustain their growth earnings. Not only this, insufficient free cash flow for growth forces a business to boost debt levels. In a worse scenario, a business without enough free cash flow may not even have the liquidity to sustain.

Final Thoughts

All in all, it is important to find an all-purpose tool that can help you test the fundamentals of your business that seem elusive. Free cash flow calculation is like a performance metric they provide entrepreneurs an opportunity to guard up if their business is not generating enough revenues.

Access our network of Investors, get instantly matched with a Lender, or get a business plan by visiting us Funded.com

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Business Opportunities for 2019

The constant change in consumer demands and requirements has led to a continuous shift in the nature of businesses and the way they are operated. Globalization and technology are changing the business world at an exponential rate.

Running a business online, something that was a far cry about 50 years ago, has become an absolute necessity today. Similarly, opportunities that might have seemed impossible are most lucrative ones to avail.

So here is a list of the top businesses, if agreed upon with utmost enthusiasm and determination, which are bound to bring success in the coming years.

E-Commerce Distribution Center

As clichéd as it might sound, the e-commerce sector is growing every year and is expected to grow by 56% by 2020. Countries that are particularly economically developed, such as the US, have a growing sense of satisfaction in its people when it comes to ordering online. The continuous rise in e-commerce markets is especially due to the increased use of smartphones.

Thus, with such favorable conditions, e-commerce markets are inevitably rising as well. Albeit platforms like Amazon (B2C), eBay (C2C), makes it a little challenging for new businesses to grow, and those who risk entering this lucrative market are bound to look for solutions with distribution.

The reason being the task of storing and distributing is a significant part of running an e-commerce business, and the increasing number of online small and medium-sized businesses will inevitably look for such services to help them compete.

Data Crunching (Consultation)

Not very long ago there was a time when data at hand was insignificant for making substantial analysis, but with the increasing use of social media platforms and websites, valuable data is generated every other second.

This idea is not only about collecting a vast array of numbers, but it is also about deciphering them in a way that gives insights and understanding to the business in question. Thus, data related fields are at a continuous rise. With the right combination of skills and resources, this business opportunity tends to be a lucrative one.

Car Charging Station

We are all aware of the increasing popularity of hybrid – all-electric cars in particular. Encouraged by the state, entailing long-term benefits and being environmentally friendly, these cars are here to stay. With an incredibly high demand for all-electric cars, such as the Nissan Leaf, which was sold out before even arriving in the showrooms, there is bound to be a subsequent rise in the percentage of existing charging stations.

Instead of hundreds, thousands need to be built in order to cater to the rising demand for electric powered cars. The idea is not only to encourage the use of this eco-friendly vehicle, but it will also, most likely, eliminate the hesitation to take cars outside the city worrying about a charging station.

Privacy Protection Firm (Cyber Security Software Company)

Year after year, cybersecurity is becoming a major area of concern for many. From money (credit cards) to communication (emails, SMS) to even personal identity (social media platforms), practically everything has a virtual presence that is vulnerable to a breach of information.

With the increasing number of cyber threats, privacy protection companies are in demand more than they ever were. We can be sure that governments around the world are now taking reactive measures of passing cybersecurity laws to prevent beaches, data leaks, and related issues.

Social Media Consultancy/ Management

Social media platforms are breaking the conventional methods of doing businesses; stats have shown about a 198 percent increase in e-commerce websites due to social media referring. That is why companies nowadays are willing to spend significant amounts on the management of their social media accounts.

Social media accounts are not only boosting leads, but also significantly increasing sales and generating valuable insights for organizations to plan ahead.

Hence, there is a rising demand for agencies and consultants who are credible enough to provide the necessary social network support that organizations nowadays are eagerly looking for.

Affordable Elderly Facilities

The aging population is the US is growing at a rapid rate. It is estimated that by 2050 around one-fifth of the entire US population will be over 65, resulting in an inevitable requirement for old age facilities.

Since there is a general perception of poor quality treatment and other problems in these accommodations, it is pivotal that all such notions be overruled by establishing accommodation that offers superior care and caters to the current and future demands of this area.

Car sharing

Drawn from the concepts of renting houses and spaces, renting cars are next in line in the renting businesses. This business has the potential to generate millions with a simple rule of thumb; to charge at least 1% of the total cost of the house/vehicle.

This business is rising at a fast rate, as there are numerous people who prefer using cars for a short period of time or have a need for another type of car that is different from theirs.

These are precisely the reasons why car-hailing services, such as Uber, have been so successful in such a short span of time.

Innovative Tech-Tools Providers

With on-going breakthroughs in technology, artificial intelligence systems, virtual reality, and so on, are in regular demand nowadays. AI is required in manufacturing as well as the service sector, while virtual reality is being used in studies (medical and art), as well as businesses to visualize business and financial models.

However, various studies have proven that gaining access to new system/technology is not nearly a challenge as implementing and sustaining that system. Change theories are not new to us; they have and will always give us a general picture of enforcing advancement in the current practices.

Hence, there is a need for catalysts – change agents – who not only deliver the right technology to meet the organization’s need, but also ensure that the people in the organization develop a certain level of comfort with their new system.

This business has a lot of potential because it will not only tap the future needs of organizations for the latest technologies, but it will efficiently bridge a gap between inventors and end consumers.

 

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