Understanding Free Cash Flow Analysis
“Check the vitals!” It’s what a doctor will demand when a patient arrives in the emergency room after a tragic accident. It’s also what they will quietly, and politely ask their nurse to do during a routine check up of a wildly healthy individual.
Key vitals are critical to understanding the state of any complex system.
We’ve discussed a margin-based approach to managing your organization, which is a wonderfully simple way to manage a business. When we drill down further, though, there’s one vital sign that is the Holy Grail of vitals.
It’s called a Free Cash Flow Analysis.
For years, I ignored having a detailed grasp on the one vital sign that would give an overall health picture of my business and I suffered greatly because of it. While it’s human to fall into avoidance or embarrassment, there is incredible agency and empowerment on the other side of drilling down on free cash flow.
It’s likely most helpful to have an understanding of a monthly free cash flow margin. Here’s how you do it:
[Total Monthly Revenue] - [Total Monthly Expenses] = [Monthly Free Cash Flow]
Make sure to include all revenue streams and all cost centers to come to these figures, include tax and debt expenses. Once you have this number for either your personal expenses or your organizations, you can understand profitability and projections at any interval you like.
Use this figure to manage capital expenditures, debt servicing, and capacity to scale.
TAKE ACTION:
AUDIT. Run the numbers above with a fine tooth comb. Use bank statements to understand expenses you’ve forgotten about and don’t forget things like insurance, utilities, software subscriptions, taxes, etc.
PRACTICE. Are you profitable? In the red? Based on this information, what’s the next logical step to take to improve cash flow? Maybe the next action to take is to take on an expense (payroll, for example) for an opportunity for future growth.