Free Cash Flow (FCF) for Financial Strength

Free Cash Flow (FCF) for Financial Strength
Brenna Lemieux
on March 16, 2020
Read in 4 min

Free cash flow can be used by companies to expand operations, absorb competitors, launch new products, and reduce debt.

If time is money, then cash flow issues likely indicate mismanagement of both precious resources.

Without a savings or some kind of cash flow cushion, your small business won’t be prepared when disaster strikes (nor will you be able to scale up.)

What is Free Cash Flow?

Like liquidity, free cash flow (FCF) is a sophisticated measure used to evaluate the status of company’s finances.

Free Cash Flow Formula

Free cash flow may be different from net income if, for example, your business has made a purchase of capital goods (or other changes in working capital.)

You can calculate free cash flow with the following formula:

EBIT (1 – tax rate) + (depreciation) + (amortization) – (change in net working capital) – (capital expenditure)

While this equation is more popular among investors evaluating publicly traded corporations, calculating free cash flow for your small business on a regular basis can reveal hidden patterns giving you a better picture of your financial situation.

In a nutshell, free cash flow shows you how much cash can be extracted from your business without affecting operations.

If your free cash flow calculation comes back negative, don’t worry.

There are plenty of proven ways small-business owners can improve free cash flow.

Here’s a concrete breakdown of five of them.

How To Free Up Some Cash Flow

1. Reconsider (and Renegotiate) Your Expenses

Last time I moved, I gleefully called my Internet provider to cancel my service –

In the new place, I’d have access to other providers, and anything would have been better than what I had.

But then the customer service rep offered me a deal.

I didn’t take it.

She offered me a better deal.

If I stayed with that provider, I could pay about half what I’d been paying.

Totally worth it.

Similar negotiation (with the intent of saving money, of course) should be part of every deal you sign as a business owner.

Think of it this way:

For service providers, the cost of managing your account is minimal compared to the cost of building and maintaining the service they’re providing.

Chances are, it will still be profitable for them to keep you as a customer at a serious discount from their sticker price.

New to negotiation? Check out these tips on getting deals from vendors.

2. Incentivize Timely Payments

You have clients. Yay!

But they don’t pay their invoices on time. Boo.

One of the primary causes of cash position trouble is when accounts receivable gets too high.

Luckily, there’s a straightforward solution to this problem.

To get paid faster, try:

Early-payment “discounts”

People love getting a deal, so offer a five percent “discount” for those who pay before their due date.

Here’s the trick: This discounted figure may actually be your full price.

Then those who pay late get the “penalty” price.

This incentivizes quick payments and punishes late payments at the same time!

Late-payment penalties

Same as the above, but with a different frame.

It’s the difference between negative reinforcement and positive reinforcement.

You know your customers best, so choose the one you think will motivate them to pay more quickly.

Payroll software

There are plenty of software programs that can help you automate invoices, monitor cash flow cycles, and keep your finances more organized.

Automating repetitive tasks can make a huge difference in the way you run your business, the way you feel about your work, and the way your customers perceive you.

Check out this review of products for options.

3. Hiring An Accountant

If your industry is complex and you need high-level help, you may want to contract the services of an accountant for a few hours a week.

It may be hard to spend money when cash reserves are low, but the long-term benefits can be significant.

Learn more about the Advantages of Hiring an Accountant

4. Consider Invoice Factoring

Even if your clients haven’t paid you yet, you can still boost your bottom line thanks to invoice factoring (also called accounts receivable factoring or invoice financing).

Here’s the basic premise of how these work:

Customers owe you money.

You don’t have cash.

Third parties will front you cash in a lump sum in exchange for your customers’ eventual payments (plus fees).

If your cashflow is really struggling, invoice factoring can provide fast relief without forcing you to take on debt –

A major plus for small business owners.

But before you sign up, be aware of the potential drawbacks:

  • Fees may accrue as frequently as weekly, and if too many customers pay late, this can become very costly.
  • If the factoring company is collecting from customers, you’ll have to communicate well to avoid confusion.

5. Try a Merchant Cash Advance (MCA)

Merchant cash advances are a hidden gem of free cash flow relief.

Like invoice factoring, MCAs use your business’s future revenue as collateral for a loan.

They also tend to have quick turnaround times, meaning you can go from cash crunch to cash cushion (and growth investment!) in as little as a week.

At its core, a merchant cash advance is cash now in exchange for a share of your revenue later (and until you’ve repaid the advance plus interest).

The biggest potential downside here is the amount of interest you pay.

Before choosing an MCA, be sure to calculate your annual percentage rate (APR), which is affected by your payback terms and the amount of time it takes you to repay the loan.

If what you payback is less than the gains you can make by having additional cash on hand, an MCA is your ticket to the gravy train.

Learn more about Refinancing Merchant Cash Advance Loans

6. Build an Emergency Fund

This is the least sexy of all the options, but possibly the most important for your long-term liquidity.

While business owners tend to be wildly optimistic, the reality is you’ll likely always want to invest in something you don’t have cash for.

With a rainy day fund for your business, you’ll be able to weather low cash stretches and seize growth opportunities when they arise.

But putting cash aside while running a small business can be daunting, especially if your free cash flow is already low.

So try this mental hack:

Make your emergency fund a line item in your monthly budget.

Every time you do your finances, you should treat these business funds as a normal business expense.

And then commit for the long haul.

Experts recommend saving between three months’ and a year’s worth of operating expenses, which won’t happen overnight.

Still, a small cushion can prevent cash crunches from becoming crises.

In any case, free cash flow is something to aspire to within your business–

It may not always be your reality.

If you struggle with the methods above, you can start the process of connecting with a loan lender using our simple online form:

See Business Lenders

Brenna Lemieux Finance Journalist

Brenna Lemieux is the author of The Gospel of Household Plants, a notary public, and an enthusiastic content marketer.

She lives and runs in Chicago.

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