What is free Cashflow? Why Should I Measure it?

A question, clients often ask is “I’ve made $150K profit so why haven’t I got $150K sitting in my bank account?”

 

The answer is simple.  Taxable profit does not necessarily equal cash profit.

Cash does disappear for a business for increased working capital, repayment of loans,capital expenditure on fixed assets or personal drawings and taxes.  All require cash expenditure none of which directly affects taxable profit.

We all measure taxable profit because we all need to calculate how much tax we have topay.  But at the end of the day, an increase in wealth can only be measured by the increase in cash in our bank accounts that is then available to invest back into the business, increase personal wealth through investing or for spending on lifestyle assets.

So free cashflow is simply a term that defines how much cash a business is generating after allowing for the cash needs of the business. It is a measure of wealth.

If we measure taxable profit on a regular basis as an indication of how successful the business is, why don’t we measure regularly free cashflow as an indicator of increase in wealth?

Best practice for our most successful clients is regularly measuring free cashflow.

By measuring free cashflow they learn about the levers that affect how much free cash they have on hand at the end of a period and what strategies they need to implement to improve cashflow.  Or, wisely take that cash and reinvest in the business to further improve profitability and cashflow.

Measuring free cashflow allows you to have options, where to best invest that money to achieve business and personal goals.

Should you wish to discuss this further contact Cameron on 378 8388 or email  cameron@mgbca.co.nz

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