Forget that old saying fake it ‘til you make it, and get your Free Cash Flow in line

Why is Free Cash Flow important for scaling companies?

Simple. Free Cash Flow (FCF) enhances shareholder value. This is an attractive metric for investors compared to price-earnings because, well, you can’t fake it honey! There are no adjustments made as is sometimes the case with the P-E ratio.

Can't Fake your Free Cash Flow

Calculating your Free Cash Flow from the Cash Flow Statement:

Free Cash Flow Formula

*formula from Investopedia

If a business can pay for operations and growth, this indicates to investors that it has a solid foundation. If a growing company has a high FCF it’s a good sign they will also have growing earnings in the nearish future.

Now you tell me… my FCF is in the red!

Don’t freak out just yet, it’s still okay to take on losses. A negative FCF isn’t necessarily a bad thing. It could be that your company’s FCF is in the red because you’ve made some large investments that could pay out in the future. As long as you can explain your dip in FCF to investors it won’t necessarily be a red flag for them.

It’s not uncommon to see startups taking losses initially until they increase revenue and the same goes for a larger company in its later stages that may be pushing to scale through reinvestment. If your reason for a negative FCF is to kick-start long-term revenue growth, your investors won’t jump ship.

“Be a master of exceptional returns”

-David G. Thomson, Bloomberg

What’s an easy way to maintain a positive FCF?

That being said, companies that are attractive to investors, do in fact have a high FCF. As Bloomberg mentioned in  The 7 Essentials of High-Growth Companies, you want to be a “master of exceptional returns. The best-run, high-growth companies are cash-flow positive early and generate more cash as they grow… as they fuel growth from their profits.” Be conservative and create a safety cushion with your revenue: Take a small portion, say, 10% of your monthly revenue and set it aside. Take the majority, or other 90%, and sit down with your accountant (or us!) and draft a budget for how that revenue is spent for operational costs. With the 10% you’re accruing you have a nice little back-up fund for things like taxes, paying off debt or simply growing it as savings for future reinvestment.

This will undoubtedly put you in good standings with your investors. That is real money and that you can’t fake!

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