{"id":800,"date":"2021-06-05T17:58:42","date_gmt":"2021-06-05T17:58:42","guid":{"rendered":"https:\/\/www.forwardai.com\/blog\/?p=800"},"modified":"2023-01-02T08:36:17","modified_gmt":"2023-01-02T08:36:17","slug":"free-cash-flow-a-deeper-look","status":"publish","type":"post","link":"https:\/\/www.forwardai.com\/knowledge-center\/blog\/free-cash-flow-a-deeper-look\/","title":{"rendered":"Free Cash Flow: A Deeper Look"},"content":{"rendered":"\r\n<p class=\"wp-block-paragraph\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-300x200.jpg\" alt=\"Free Cash Flow A Deeper Look\" width=\"670\" height=\"446\" class=\" wp-image-6047 aligncenter\" srcset=\"https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-300x200.jpg 300w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-1024x683.jpg 1024w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-768x512.jpg 768w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-1536x1024.jpg 1536w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-2048x1365.jpg 2048w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-360x240.jpg 360w, https:\/\/www.forwardai.com\/knowledge-center\/wp-content\/uploads\/2021\/06\/c-41604-1672647930914-ac583d0cb0231391098b78b43437a7d1-1-272x182.jpg 272w\" sizes=\"auto, (max-width: 670px) 100vw, 670px\" \/><\/p>\r\n<p>At Forwardly, we often talk about how cash flow is the best indicator of your <a href=\"https:\/\/www.forwardai.com\/forwardly\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/category\/forwardai-predict\/\">business\u2019s financial health<\/a>. (And we truly mean\u00a0<em>often<\/em>.) But there\u2019s a metric within the bigger umbrella of cash flow that drills down on your survival odds as a company: Free cash flow.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Free cash flow lets your business really see what kind of cash your company has available to work with after it pays for operations and capital expenditures. It\u2019s a bit less straightforward number than just looking at an income statement. But, if you do the legwork, like running\u00a0<a href=\"https:\/\/www.forwardai.com\/forwardly\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/predict\/\">regular cash flow forecasts<\/a>\u00a0using our insights and analysis, you\u2019ll have an invaluable perspective on whether your business has the runway to invest \u2014 and the potential to grow.<\/p>\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>Free cash flow defined<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Most simply, free cash flow is the remaining portion of your business\u2019s cash flow that you can safely access after the necessary expenses are paid for. Most often, it\u2019s mentioned into context what you can \u201cdistribute.\u201d But as a small business owner, you don\u2019t need shareholders for that to be relevant.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Distributions include payouts to equity holders (including yourself as the proprietor of a business), but also those who hold debt (like any business lenders or other debtors), and any investors if that\u2019s relevant for you, too.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Importantly, free cash flow is a short-term metric.<\/p>\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>How to calculate free cash flow<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Grab your most recent\u00a0<strong><a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/how-to-read-a-cash-flow-statement\/\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/wp-admin\/post.php?post=21&amp;action=edit\">cash flow statement<\/a><\/strong>. There are a few different ways to calculate free cash flow, but the most straightforward among them is:<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\"><strong>Net Operating Cash Flow \u2013 Capital Expenditure =\u00a0<em>Free Cash Flow<\/em><\/strong><\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Wherein operating cash flow (OCF) means:<\/p>\r\n\r\n\r\n\r\n<ul class=\"wp-block-list\">\r\n<li>Cash you make from business as usual, minus your long-term investments and taxes.<\/li>\r\n<li>OCF takes into account depreciation expense by adding it back in.<\/li>\r\n<li><em>You can find your OCF number on your cash flow statement.<\/em><\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Wherein capital expenditures (Capex) means:<\/p>\r\n\r\n\r\n\r\n<ul class=\"wp-block-list\">\r\n<li>Cash you\u2019ve spent on\u00a0<a href=\"https:\/\/finserve.byu.edu\/asset-capitalization-procedures\" target=\"_blank\" rel=\"noreferrer noopener\">capitalized fixed assets<\/a>, including expanding, upgrading, or maintaining your systems, equipment, space, etc. for business<\/li>\r\n<li>Capex takes into account depreciation expense by adding it back in<\/li>\r\n<li><em>You can find your Capex number on your cash flow statement in the \u201cinvesting activities\u201d line<\/em><\/li>\r\n<\/ul>\r\n\r\n\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>How free cash flow differs from net income<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">If this sounds a bit like your net income, you\u2019re not off base \u2014 but free cash flow has an important difference. Your net income takes into account\u00a0<a href=\"https:\/\/www.investopedia.com\/ask\/answers\/080216\/how-does-depreciation-affect-cash-flow.asp\" target=\"_blank\" rel=\"noreferrer noopener\">depreciation<\/a>. (The free cash flow formula adds depreciation back in, as you can see reflected above.)<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">For instance, say you make a big purchase on a commercial oven for your organic granola company. But you have to pay for it all up front. Although your net income, which you pull from your income statement, will give you one number that factors in depreciation, your free cash flow will indicate a different total. Since your free cash flow gives you a snapshot of the short term, you\u2019ll see a more constrained cash flow number because you paid in a lump sum.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Depreciation is set up within the mechanisms of accounting by design to lessen the blow of a big asset purchase.\u00a0<em>(The IRS\u2019s term for this deduction is \u201c<a href=\"https:\/\/www.irs.gov\/businesses\/small-businesses-self-employed\/a-brief-overview-of-depreciation\" target=\"_blank\" rel=\"noreferrer noopener\">cost recovery<\/a>.\u201d)<\/em>\u00a0On the other hand, free cash flow\u2019s\u00a0<em>this-very-second<\/em>\u00a0approach to your spending makes sure your costs are recorded as they happen \u2014 that\u2019s why depreciation is handled differently. In short, with cash flow, you\u00a0<em>want\u00a0<\/em>to see how that big expenditure affects your bottom line ASAP.<\/p>\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>What your company\u2019s free cash flow can tell you<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Free cash flow is meant to be a short-term metric \u2014 and it is. You can learn a lot about your financial solvency as a company, both the now and future, if you contextualize your numbers correctly.<\/p>\r\n\r\n\r\n\r\n<h3 class=\"wp-block-heading\"><strong>Free cash flow in the short term<\/strong><\/h3>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Calculated once, your free cash flow gives you a pretty solid sense of your business\u2019s true liquidity or ability to meet its current and near-term financial obligations. And that\u2019s important. If you\u2019re planning to distribute earnings or wages\u00a0<em>(including to yourself \u2014 an entrepreneur can only eat so much ramen)<\/em>. You also need to be able to do so knowing that it won\u2019t happen at the cost of keeping the lights on.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Plus, if you have outstanding business loans \u2014 or even\u00a0<a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/business-credit-cards-how-to-use-them\/\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/wp-admin\/post.php?post=28&amp;action=edit\"><strong>business credit card bills<\/strong><\/a>\u00a0\u2014 understanding what you\u2019re able to siphon off your cash reserves is essential. Especially if you have something like a\u00a0<strong><a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/business-line-of-credit-the-basics\/\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/wp-admin\/post.php?post=143&amp;action=edit\">business line of credit<\/a><\/strong>, wherein you have, say, a six-month window to pay back what you borrowed. Knowing you have the cash to pay back your lender now means you don\u2019t have to worry about extra fees, penalties, or interest.<\/p>\r\n\r\n\r\n\r\n<h3 class=\"wp-block-heading\"><strong>Free cash flow in the long term<\/strong><\/h3>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">As with most financial metrics \u2014 and data in general \u2014 the more free cash flow calculations you have, the better. If you see an upward trend in your company\u2019s free cash flow, it\u2019s a strong hint toward growth. It also gives you the opportunity to invest and reinvest in your company.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Since no one number tells a complete story, you\u2019d have to dig into P&amp;Ls and\u00a0<a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/balance-sheet-basics-for-business-owners\/\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/wp-admin\/post.php?post=790&amp;action=edit\">balance sheets<\/a>\u00a0to figure out what\u2019s going right. Maybe you\u2019re doing a good job at keeping your costs low as you\u2019re able to increase your prices relative to market competitors. Maybe you\u2019re expanding your customer base and lowering your customer acquisition cost (CAC) in the process. Whatever you\u2019re doing, consistently increasing free cash flow generally indicates positive financial health.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">On the other hand, a downward trend in free cash flow over a longer period of time will be able to raise your red flag. Why are you experiencing an earnings decline? Are you managing your assets efficiently and investing the right way? (And do you need\u00a0<a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/how-cash-flow-consulting-helps-businesses\/\" data-type=\"URL\" data-id=\"https:\/\/www.forwardai.com\/blog\/wp-admin\/post.php?post=207&amp;action=edit\">help<\/a> turning things around?)<\/p>\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>Why free cash flow matters<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">If we asked you,\u00a0<em>How\u2019s your business doing?\u00a0<\/em>You\u2019d have one answer to the question. If we asked an outside evaluator to come in, thumb through your exact same financial statements, and respond to the prompt, they\u2019d very likely have something different to say. It has nothing to do with you. Rather, there are lots of ways you can read and interpret\u00a0<a href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/forwardai-predict\/5-stories-your-financial-statements-tell\/\">the stories your financial statements tell<\/a>.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Cash flow is already among the least gray financial metrics to interpret. Your cash position paints a straightforward picture \u2014 either you\u2019re cash flow positive or cash flow negative. (And the more work you do creating cash flow forecasts with insights from Forwardly, the quicker you can make adjustments so the latter never happens.)<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">But even within cash flow, there\u2019s something called a cash \u201csmoothing\u201d effect which can change the accuracy of your cash reporting. Some businesses use\u00a0<a href=\"https:\/\/bench.co\/blog\/accounting\/cash-vs-accrual-accounting\/\" target=\"_blank\" rel=\"noreferrer noopener\">accrual basis accounting<\/a>\u00a0(versus cash basis), which reports and records both revenues and expenses as they happen, not when they\u2019re received or incurred. That can sometimes cause a less accurate representation of their short-term cash. This is that\u00a0<em>smoothing<\/em>, which essentially spreads (aka smooths) this cash data out over a longer period of time.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">The numbers your accounting data provides is still entirely accurate in terms of net income \u2014 don\u2019t worry. But free cash flow takes into account that smoothing and attempts to mitigate it. As a result, it\u2019s harder to manipulate.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Hence, free cash flow is an even more precise way to get a sense of a business\u2019s available cash.\u00a0<em>(It\u2019s even a favorite metric for investors evaluating Wall Street securities, so you\u2019ll be in good company using it.)<\/em><\/p>\r\n\r\n\r\n\r\n<h2 class=\"wp-block-heading\"><strong>Gathering as much cash flow data as possible<\/strong><\/h2>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">If you research more about free cash flow, you\u2019ll find there are quite a few more ways to calculate it and apply it to corporate finance. We\u2019ll advise you not to worry about the others as a small business owner. (They\u2019re a bit more in the weeds, geared toward huge public companies with lots of shareholders.) Just the general overview of free cash flow will be enough for you to understand more about your business\u2019s assets at a deeper level.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">That said, we did say more data is better, right? And we stand by it. Because there\u00a0<em>are<\/em>\u00a0many cash flow insights that are immensely helpful for you to make better data-based decisions every day as a business owner.<\/p>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\">Forwardly cash flow forecasting tool provide the deep, nearly up-to-the-minute numbers to help you make the best calls for your company by pulling your latest financial information directly from your accounting software.<\/p>\r\n<table class=\"table-warning\">\r\n<tbody>\r\n<tr style=\"height: 44px;\">\r\n<td style=\"width: 651px; height: 44px;\"><strong>Improve your cash flow instantly, so you don&#8217;t have to worry about it 24\/7.<\/strong> Forwardly simplifies cash flow management, so you can do it all from one place. Amplify your business cash flow and bring certainty to your business&#8217;s future. <strong><a href=\"https:\/\/www.forwardai.com\/forwardly\">Sign up now for free.<\/a><\/strong><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n\r\n\r\n\r\n<p class=\"wp-block-paragraph\"><em>The information in this article is not financial advice and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.<\/em><\/p>\r\n<p>&nbsp;<\/p>\r\n<p>Image: GraphicStock.<\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>At Forwardly, we often talk about how cash flow is the best indicator of your business\u2019s financial health. (And we truly mean\u00a0often.) But there\u2019s a metric within the bigger umbrella of cash flow that drills down on your survival odds as a company: Free cash flow. Free cash flow lets [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-800","post","type-post","status-publish","format-standard","hentry","category-blog"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.5 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Free Cash Flow: A Deeper Look - ForwardAI<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.forwardai.com\/knowledge-center\/blog\/free-cash-flow-a-deeper-look\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Free Cash Flow: A Deeper Look - ForwardAI\" \/>\n<meta property=\"og:description\" content=\"At Forwardly, we often talk about how cash flow is the best indicator of your business\u2019s financial health. 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