One of the main graphs shown in the financial projections template is the free cash flow graph.
Free cash flow (FCF) is the cash flow available after the business has paid for all of its operating needs including providing working capital, and invested in property, plant, and equipment (capital expenditure) necessary to maintain its current growth rate.
The purpose of calculating free cash flow is to show what cash is available (free) to the providers of finance of the business. This free cash flow can then be utilized to reduce the debt or pay dividends to equity providers. In addition, free cash flow might also be available to improve the growth rate of the business by taking advantage of expansion opportunities and investing in new products.
Free Cash Flow Formula
The free cash flow formula is as follows:
Free cash flow = Cash flow from operating activities - Capital expenditure
The information required to calculate free cash flow is taken from the financial projections cash flow statement.
How to Calculate Free Cash Flow
If we look at the basic cash flow statement below, the highlighted elements represent the main components of free cash flow of the business.
|Add back depreciation||14,000|
|Net cash flow||9,430|
|Opening cash balance||966|
|Closing cash balance||10,396|
In the above cash flow statement, the cash flow from operating activities is 14,930 and the investment in property. plant, and equipment (capital expenditure) is 10,000. Assuming all the capital expenditure was necessary to maintain the current growth rate of the business, then the free cash flow (FCF) is calculated as follows:
FCF = Cash flow from operating activities - Capital expenditure FCF = 14,930 - 10,000 FCF = 4,930
In this example, after the business has paid for all of the operating requirement including any necessary working capital, and invested in property, plant and equipment to maintain its current rate of growth, the free cash flow available to the providers of finance of the business is 4,930.
Free Cash Flow and Financial Projections
It is important to understand and monitor free cash flow as providers of both debt and equity finance will look at the amount available for indications that the business has sufficient cash to take advantage of expansion opportunities, develop new products, reduce debt, and pay dividends.
Free cash flow is one sign of a healthy business, and our financial projections template will help you to keep a check on its projected level, by calculating the amount of free cash flow and presenting this in the form of a line graph for each of the five years .
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.