Having the free cash flow formula and knowing how to calculate it will be essential to be more organized regarding your financial statements.
When businesses expand, they often turn to lenders to secure the necessary funds. During the loan application, as small business owners, you will require to provide various information, including financial statements and a comprehensive business plan.
Lenders want to see the free cash flow of your business to ensure the owner will be able to pay back the debt comfortably.
This article will help you through the basics. Every business owner should know the basic cash flow, and understanding how to do it may seem a bit difficult at first. Yet it’s relatively easy to obtain.
What Is Free Cash Flow?
Free cash flow (FCF) looks at how much cash your business generates from sales once you subtract outgoing payments for expenses (excluding taxes and interest).
When you ask for funding, the lenders often look at the cash flow statement because they are likely not to pay their bills if a business runs out of cash. Your income statement, in some cases, is a reason to approve or deny credit.
Imagine for a moment that you have a business checking account, and that account is the only place where you transact funds for your business.
If you looked at the account on the 1st of January in one year and then look at it again a year later, the change in balance is your free cash flow.
While this oversimplifies the actual measurement, it provides an excellent guide to understanding how free cash flow works.
Operating vs. Free Cash Flow
The main difference between free cash flow and operating cash flow is whether you include capital expenditures. Free cash flow always includes capital expenditures on the plant, equipment, etc. Operational cash flow excludes these items.
- Operating cash flow gives you a good picture of how your business generates cash from operations.
- Free cash flow tells you how much cash you have at the end of the day after you do everything for the business.
When you look for loans to buy equipment or expand your facilities, you’re looking at free cash flow. Why?
If you’re looking for loans to increase hiring, you want to look at both free cash flow and operating cash flow. Why?
Because labor is part of your ongoing operations, it’s crucial to understand how to calculate free cash flow. Otherwise, you may borrow too much or too little.
Operating Cash Flow Formula
To calculate the OCF, you just need to deduct operating expenses from your revenue.
OCF= revenue – operating expenses
Operating Cash Flow—also known as cash from operations—does not include capital expenditures. That’s what differentiates it from free cash flow.
How to Define “Positive” Free Cash Flow
In order to truly understand the FCF of a company, you can’t just look at the result of a single month or week. It is recommended that you graph the FCF for as many months as you can.
If the business has a good free cash flow, you will be able to see a stable, positive trend.
How To Calculate Free Cash Flow? – Use the Free Cash Flow Formula
The following is a free cash flow formula for creating your cash flow statements.
FCF = Cash from Operations – Capital Expenditures
This a breakdown of the FCF formula below:
FCF = Net Income + Non-Cash Expenses – Increase in Working Capital – Capital Expenditures
4 Steps to Calculate Free Cash Flow
Once you understand how to calculate free cash flow, you’ll be able to have the tools to apply for loans. The basic steps for the free cash flow formula:
- Add up the revenues you received payment on (nothing you still have to pay).
- Subtract any expenses you paid cash for
- Subtract any costs for interest on loans and taxes
- Subtract any purchases you made on equipment or other large purchases you plan to depreciate
The other way you can calculate cash flow is by taking your net profit and adding back in non-cash items like depreciation or changes in inventory value. Then follow steps 3 & 4. In a nutshell, you’re trying to just look at the net movement of cash in and out for your business.
Once you understand how to calculate your free cash flow, you can check out this other article to guide you through setting up a free cash flow statement.
How do you calculate cash flow? – Other scenarios
Understanding the free cash flow formula is important when asking for funding for your business. Here are other formulas according to your needs:
How do you calculate cash flow from operations?
Cash Flow from Operations = Net income + non-cash items + adjustments for changes in working capital
How do you calculate the net cash flows?
Net Cash Flow = Operating cash flow + Invested cash flow + Financing cash flow.
How do you calculate real estate cash flow?
Real Estate Cash Flow = Rent income – Vacancy loss – Expenses
You may be interested in Cash Flow Problems and Solutions
Benefits And Importance of Calculating Free Cash Flow
The FCF shows how quickly money flows in and out of business. This can give you an insight into your business’s financial health.
Business owners keep an eye on their working capital daily, weekly, monthly, and annually. They want their free cash flow to stay in a safe range month-to-month and year-to-year without dipping into dangerous financial zones.
An FCF that falls consistently can indicate that customers don’t pay their bills on time, or vendors may require quicker payments, which wreak havoc on available cash when combined.
An income statement shows costs, expenses, and revenues but doesn’t reveal when a business’s FCF drops.
Additionally, predicting your FCF helps shareholders and lenders evaluate your business’s ability to pay dividends or repay a loan now and in the future. Likewise, investors shy away from investing in companies with a negative FCF.
What Is The Levered and Unlevered Free Cash Flow
Unlevered Free Cash Flow
Simply defined, the unlevered free cash flow is how much cash flow equity and debt holders can access after accounting for investments, capital expenditures, and operating expenses.
The term also referred to as free cash flow to the firm (FCFF), helps determine the total value of a company after paying all debt.
Unlevered Free Cash Flow Formula
The UFCF equals the sum of your earnings before interest taxes, depreciation and amortization minus capital expenditures (CAPEX), working capital, and any taxes you owe.
UFCF = EBITDA – CAPEX – working capital – taxes
Levered Free Cash Flow
Determining your levered free cash flow lets you know your business’s capital after deducting short and long-term financial commitments.
Also known as a free cash flow to equity, your LFCF signals to owners, investors, shareholders, and others your business’s financial health and expected long-term sustainability.
Levered Free Cash Flow Formula
Determine your LFCF by adding together earned income before interest, taxes, depreciation, and amortization (EBITDA) and deducting the change in net working capital, capital expenditures (CAPEX), and your mandatory debt payments owed to debtors.
LFCF = EBITDA – change in net working capital – CAPEX – mandatory debt payments
COVID-19 and Cash Flow
The current COVID-19 crisis is affecting business owners in unexpected ways. Some have seen their sales decline or forced to close, wreaking havoc on their bottom lines temporarily.
As a business owner, you might be having some cash flow issues. But don’t worry, the future is not as grim as it may sound: this won’t last forever, and there are still some things you can do to ensure your business weathers the storm.
We recommend doing some, if not all, of these things:
- Apply for government aid, as it will help your business stay strong.
- Talk to your clients and suppliers to create new payment terms and payment facilities.
- Find new channels to sell your products and services. Right now, the internet is your best friend.
- Talk to your accountant; they might know of specific things you can do to help your business.
- Get external financing.
One last thing you should do is to keep yourself informed. To help you and other business owners, we created a content hub that lists a myriad of articles that can help you survive this crisis.
Options to Getting Cash for Your Business
Understanding the free cash flow of your business will help you determine the right loan amount. Obtaining cash for your business can be a crucial ingredient in helping you expand or work through unexpected events that come up. Regardless of your case, there are many options available to you.
Depending on why you need the cash and how much your free cash flow formulas say you require, there are several options for obtaining capital, which we’ll divide into two major categories:
Short-term Revolving Lines
- Lines of Credit
- Credit Cards
Long-term Installment Loans
- Secured Installment Loans
- Unsecured Working Capital Loans
These particular options allow borrowers to pay interest on the outstanding balances, allowing them to reduce interest payments as they reduce their balances.
Usually, these types of credit are easier to apply for and require less information. However, because these products are more flexible and easier to come by, they usually involve higher interest rates.
Installment loans are more suitable for long-term investments, and you must pay them within 2 and 7 years.
With secured installment loans, you can get much better interest rates than you might receive from lines of credit. But the trade-offs are that they usually require more information than lines of credit and do not always offer as much flexibility in the product.
“Secured” means that you will need to pledge collateral that guarantees you can return the money.
At Camino Financial, we offer unsecured working capital loans, which do not require you to pledge collateral for the loan. In this case, only a bankruptcy court can seize your personal assets.
Our loans don’t have pre-payment penalties, either. What does this mean? It means that we won’t charge you any fees if you decide to repay your loan early. This makes them an excellent candidates for bridge loans.
How Can Camino Financial Help You Fund Your Working Capital Needs
One of the great things about working with Camino Financial is our online process is extremely easy to follow with three easy steps:
Submit an online application to receive pre-approved terms
Click here and complete a mobile-friendly loan application (it should take you between five and ten minutes). You do not require documentation, and applying will not impact your credit score.
Review the loan terms and authorize the download of your bank activity
Within one business day, you’ll receive a text with the pre-approved terms of your loan, and your assigned business loan specialist will contact you. After reviewing the terms, take one minute to authorize Camino Financial to download the last six months of bank account activity to verify your business income. Rest assured, this step of the process is totally secure. Depending on your credit profile and loan terms, your business loan specialist may request additional documentation to verify your income.
Sign the loan contract and get funded
The credit department will take between 1 to 8 business days to review your loan application. Upon receiving final approval, sign the mobile-friendly loan contract, you’ll receive via email. You’re done! You will receive the funds directly to your bank account within two business days.
To sum up, you can get a business loan within 1 to 10 business days with less than a single hour invested in your time.
With loan products that adapt to your needs
We offer business term loans that range between $5,000 to $400,000. Through fixed monthly payments, our clients pay our business loans down over 24 to 60 months. Our monthly interest rates vary from 1.0% to 2.5%.
With tools that allow you to be in control of how much you want to pay
If you want to evaluate the terms of a potential loan before submitting a formal application, feel free to try our online loan calculator. It will allow you to measure the monthly payments at different loan terms. Simply input:
- The amount you want to request
- The number of monthly installments you want for your credit; between 24 and 60
- The monthly interest rate
After entering these three figures, click “Calculate.” All the information you need will show up on the screen. You can reset this information as many times as you want until the result completely fits the needs of your business.
As you can see, working with Camino Financial allows you to obtain the benefits of a personalized solution with a lender that cares about getting you an affordable rate on the right sized loan for your business. We know that applying for a business loan can be a scary process.
However, we work hard to make this as easy and as transparent as possible. We strive to bring you the best financing solutions to help you achieve incredible success.
Frequently Asked Questions About Free Cash Flow
How to calculate cash flow?
Cash flow is the amount of cash your business generates from business operations and activities minus your expenses.
You can access the information by pulling up a cash flow statement for a specific period if you use accounting software.
Remember that accountants make year-end adjustments for depreciation, amortization, losses, etc., to reflect yearly increases or decreases in cash.
What does free cash flow show?
The amount indicates how much it costs to run a business which is easily determined by taking the net operating cash flow amount and subtracting the total capital expenditures (you can find both on a cash flow statement).
Why is free cash flow important?
Free cash flow gives a clear picture of how well a business owner sustains and operates their business. As a result, they can quickly identify and pursue steps for improving cash flow to grow their business.