Why is Free Cash Flow Important for Scaling Companies?
Simple. Free Cash Flow (FCF) enhances shareholder value. This is
an attractive metric for investors compared to price-earnings
because, well, you cannot fake it, honey! There are no adjustments
made as is sometimes the case with the P-E ratio.
Calculating Your Free Cash Flow from the Cash Flow
Here is how you can calculate your FCF:
– Changes in Working Capital
– Capital Expenditures
= Free Cash Flow
If a business can pay for operations and growth, this indicates
to investors that it has a solid foundation. If a growing company
has a high FCF it is a good sign they will also have growing
earnings in the near future.
Now You Tell Me... My FCF is in the Red!
Don't freak out just yet, it is still okay to take on
losses. A negative FCF is not necessarily a bad thing. It could be
that your company's FCF is in the red because you have made
some large investments that could pay out in the future. As long as
you can explain your dip in FCF to investors it will not
necessarily be a red flag for them.
It is not uncommon to see startups taking losses initially until
they increase revenue, and the same goes for a larger company in
its later stages that may be pushing to scale through reinvestment.
If your reason for a negative FCF is to kick-start long-term
revenue growth, your investors will not jump ship.
What is an Easy Way to Maintain a Positive FCF?
That being said, companies that are attractive to
investors do in fact have a high FCF. As Bloomberg mentioned
in The 7 Essentials of High-Growth
Companies, you want to be a, "master of
exceptional returns. The best-run, high-growth companies are
cash-flow positive early and generate more cash as they grow [and]
as they fuel growth from their profits."
Be conservative and create a safety cushion with your revenue:
Take a small portion, say, 10% of your monthly revenue and set it
aside. Take the majority, or other 90%, and sit down with your
accountant (or us!) and draft a budget for how that revenue is
spent for operational costs. With the 10% you are accruing you have
a nice little back-up fund for things like taxes, paying off debt
or simply growing it as savings for future reinvestment.
This will undoubtedly put you in good standings with your
investors. That is real money and that
you can't fake!
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Determining the locus of ownership of intangible property related to the development of new products and services is one of the principal challenges that tax managers in multinational enterprises (MNEs) face on an ongoing basis. Tax managers must balance non-tax corporate objectives, tax efficiency, tax risk management, and financial reporting considerations.
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