The very first step to maximise your operating cash flows in your company is to identify the root of the problem. One of the best ways is to use a financial metric known as free cash flow (FCF).
In simple terms, a company’s cash cycle for any period can be classified into:
- Operating (sales, purchases, salaries, rental, utilities, etc)
- Investing (purchase of fixed assets, investment in companies)
- Financing (bank loans).
FCF can be extracted from your statement of cash flows in your report by taking net cash flow from operating activities minus your capital expenditure (i.e. purchase of fixed assets and intangible assets under investing activities).
If your FCF for the year is in a large positive surplus, it means that your company is strong enough to finance any operations with its own funds.
FCF can be used for the following to name a few: paying dividends, expansion, repayment of loans, etc.
FCF has been widely used in finance to value a company because it is based on cash flow rather than profits which can be easily manipulated.
If a company has a positive FCF of $100,000 but a capital expenditure of $200,000 for the year, a relook have to be done on the bulk of capital expenditure incurred.
However, if a company has a negative FCF of $100,000, you may have to focus on relooking your operational cycles e.g. your debtor and payment cycles, etc.
As with all other calculations, the figures will be inaccurate if the inputs are wrong e.g. non-cash items included, wrong classification of related parties’ transactions, etc.
