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If you’ve dipped into accounting because you’re thinking about starting up a business, then you may have come across the term “free cash flow.” But what exactly is FCF, and why is it important?
What Is Free Cash Flow?
Free cash flow is the amount of money your business generates after deducting operating expenses and the cost of buying assets, like equipment or buildings. Free cash flow, therefore, is what matters when you want to buy anything else for your business, like hiring new people, reducing debt, or paying yourself a dividend.
Why Is Free Cash Flow Important For Small Businesses?
Strategy consulting firms know how important it is for businesses to have healthy FCF to expand their operations and grow. But it’s not something that’s appreciated by many owners themselves. Here’s why FCF is so essential.
Strong FCF Improves Your Negotiating Position
Companies that have strong FCF are able to meet their obligations to suppliers more reliably. A business generating excess cash above regular expenses has more money on-hand, there and then, to pay other firms for the services it needs to provide value to customers.
From the perspective of other businesses, this is a good thing. The more cash that a company has available, the more likely they are going to be paid and, hence, the more likely they are to offer favorable rates. Take a lender, for instance. A lender, like a bank, who can see that your firm is generating extra cash every month is much more likely to lend at a lower rate than if your FCF is negative because they believe that they stand an excellent chance of being paid back.
Suppliers also like lots of free cash flow. The last thing they want is to make a delivery to your firm, only to find out that you don’t have the funds available to pay them.
Good FCF Helps To Pay Down Debt
We’re currently living through something of a debt explosion. Companies, both large and small, are taking advantage of low-interest rates to fuel their activities. But many see the era of low-interest rates coming to an end. Central banks have already committed to raising rates, and quantitative easing has come to an end.
Businesses with good FCF are in a much better position to service their debt and pay it down than other companies in the market. If you can secure good cash flow at the end of each quarter to meet your debt obligations, you can reduce your overall payments long term.
Good FCF Gives You Freedom To Invest
Finally, having good FCF gives you the financial freedom you need to do what you want. You can either take the FCF in the form of a personal dividend, boosting your own income, or you can keep cash on-hand to take advantages of opportunities when they come your way: the choice is yours.
Building efficiency and leanness are essential if you want to be able to generate plenty of FCF. Is your company lean?