Are you earning what you think you’re earning? You may have an idea of how much are the current profits in your small business, but have you thought of how relevant it could be to have an exact idea of it? Believe it or not, not many business owners are aware of the importance of knowing their Free Cash Flow. But before getting into the details of why it is important, you should first understand what Free Cash Flow is and why calculating it can be an advantage to move forward with your business plans.
What’s Free Cash Flow?
According to Investopedia, Free Cash Flow is “the cash a company produces through its operations, less the cost of expenditures on assets”, meaning that Free Cash Flow is the money your small business actually earns after paying for all the operating costs like electricity, internet, tools, after paying taxes and also paying all of your employees.
The cash you have left after all this is what you can use to do whatever you want. You can re-invest it on your business or use it as owner earnings. Having a strong Free Cash Flow helps you measure the actual success of your business and it is an asset to get a business loan.
So, if you’re still unsure on how to calculate your Free Cash Flow, keep reading, we will guide you a bit through the process with the story of Andrea and her bakery.
Andrea González is a Colombian entrepreneur who owns a small bakery shop in San Jose, California. In 2018 her net profit was $500,000. She wanted to calculate her Free Cash Flow to decide how she could move forward with her company so she used 4 simple steps to do the calculation:
- She got her annual net profit ($500,000) and subtracted all the expenses she had during the year, meaning the salary of her 2 employees, the raw material, electricity, gas, etc. Which accounted for $250,000.
- To this amount she added the paid taxes, so she now got $290,000.
- And since she was still paying a loan she got during 2016, she added the interests and the sum went up to $310,000.
- With the help of her accountant, she added to this amount all her non-cash expenses like amortization and depreciation, leaving her with a final sum of $325,000
But this is not her Free Cash Flow yet: she took her initial net profit and subtracted the $325,000, so the formula looked something like this: FCF = $500,000 – $325,000 = $175,000. Her Free Cash Flow can be considered good enough, so when she was certain about her Free Cash Flow, she could make a decision on her following step: Andrea was looking forward to expanding her bakery and make it a coffee shop as well, so she needed extra cash to continue with this expansion project.
Thanks to the fact that she calculated her Free Cash Flow and got all her financial documents in order, Andrea was able to get a loan quite easily by demonstrating that her free cash flow was solid enough. With the help of her impeccable credit history, she’s now starting the coffee shop section at her bakery, adding some extra value for the customers who already love what she does. By being able to invest a bit more in marketing, she’s even getting new customers.
It’s Your Turn to Calculate Your Free Cash Flow
Just like Andrea, you can also calculate your free cash flow in 4 easy steps and continue growing your business the way you always imagined.
It might look confusing and hard to do at first, but if you have all the financial statements of your business in order, finding the information you require and adding up together is easy, or you can always consult your business accountant to get more information about your free cash flow.
There are a lot of loan opportunities out there, and even though it’s not an easy path to follow, it could certainly be what your business needs. Now that you know how to calculate your Free Cash Flow, you are already covering one of the most common requirements for a business loan and you can make an informed decision.