What’s Free Cash Flow?

Written by Elements Advisory Group
December 6, 2022
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cash, cash flow, financial performance, growth, margin, pricing strategy, profit, profitability

Funding your growth strategy with free cash flow. 

Is your business toeing the line between profitability and breaking even? Perhaps growth seems out of the question at the moment as revenue dwindles month to month. Even a low business valuation, or having a lender reject an application for finance can indicate that your free cash flow isn’t healthy. Profitable growth is directly linked to free cash flow and may be the key to unlocking new growth opportunities for your business. But what is free cash flow?

Free cash flow versus cash flow

Free Cash Flow (FCF) measures a company’s ability to produce cash and their potential to grow and expand thanks to healthy profits. It is a key factor in determining the value of a business. Calculating your business’s free cash flow is different to measuring liquidity or even working capital. Where liquidity refers to the availability of liquid assets (such as cash) and working capital encapsulates the capital a business uses in its day-to-day operations, free cash flow excludes a number of revenue and expense accounts. It gives a much more accurate idea of capital available to reinvest into the business. 

Investor appeal 

Not only does having good FCF demonstrate a business can meet their expenses month to month (and have some leftover), it puts the business in a good position to expand. This leftover cash can be used in a discretionary way because it isn’t tied up in paying down debt or wages, and investors will look favourably on businesses with such positive profitability. An unhealthy free cash flow can make growth extremely difficult for a business. 

What if free cash flow is poor?

If you have enlisted the support of a business advisor to conduct a FCF calculation, or if the business is shrinking with waning interest from investors, it’s time to improve your free cash flow. Improving your FCF and profitable growth go hand in hand. If your free cash flow is negative, there are some things you can do.

Here are four ways of achieving profitable growth with a healthy free cash flow.

Raise your prices 

Your pricing strategy needs to include a buffer for profit. Otherwise, you’ll constantly be breaking even. Look for ways to add value to your current product or service offerings. Overdelivering on customer service, quality of produce, and interactions across digital touchpoints (such as your website and social media) and looking for creative ways to surpass competitors will justify a price increase, even if your base costs remain the same. 

Increase sales volume

Harness the power of marketing and move more stock. Or, if you are a service-based business, book more projects and jobs. Rather than reinventing the wheel, utilising your existing customer database to push more sales is a cost-effective starting point to improve your free cash flow. 

Decrease direct costs and overheads 

Direct costs are tied to your outputs and overheads are the expenses associated with running your business. Looking at ways to decrease your direct costs could include adjusting employee rosters to decrease wages, asking wholesalers to bundle materials at a lower cost (or shopping around– the raw materials market may be more competitive than you initially thought) and taking stock of freebies and amenities which may be draining your cash flows. Overheads such as insurance, rent, subscriptions, IT assistance and failing to automate or outsource time-consuming jobs will also need to be examined to improve free cash flow. 

Change the product mix 

Are the products and services you currently offer actually meeting market demand? By looking at the quality, function and appearance of your current offerings, you can adjust what you’re selling to the public. It’s best to conduct market research and develop a strategic plan to help make profitable growth changes.

Ready to fund your growth strategy with a healthy free cash flow? 

Email our specialist advisors today at admin@elementsag.com.au or call us at 07 3878 9181.

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