Free cash flow calculator: how much cash does the business really make?

The free cash flow formula

• Free cash flow = operating cash flow − capital expenditure. Use this when you have a cash flow statement (in Xero, the Statement of Cash Flows).
• Free cash flow = net profit + depreciation and amortisation − increase in working capital − capital expenditure. Use this when you start from the Profit and Loss and Balance Sheet.
• The increase in working capital is the increase in what customers owe plus the increase in stock, less the increase in what you owe suppliers. Money stuck in debtors and stock has not reached the bank yet.
• Capital expenditure (capex) is what you paid for vehicles, machinery, computers and fit-out, less what you got for any you sold.

What is left is the cash the business produced on its own. It is what pays the owners, repays the loans and builds a buffer. If drawings, dividends and repayments are bigger than free cash flow, the difference comes out of the bank or from new borrowing.

Free cash flow calculation: a worked example

An electrical contractor in Australia, one year. Made-up figures to show the arithmetic.

	$
Net profit after tax	120,000
Add back depreciation	18,000
Customers owe 25,000 more	(25,000)
Stock up 5,000	(5,000)
Owe suppliers 6,000 more	6,000
Operating cash flow	114,000
Two new utes	(90,000)
Old ute sold	15,000
Free cash flow	39,000
Dividends paid	(60,000)
Loan repayments	(12,000)
Left after owners and loans	(33,000)

Check: 120,000 + 18,000 − 24,000 = 114,000 of operating cash flow (the 24,000 is 25,000 + 5,000 − 6,000). Capex was 90,000 − 15,000 = 75,000, so free cash flow is 114,000 − 75,000 = 39,000.

What it says to the owner:

• Only about a third of the profit became free cash. 39,000 ÷ 120,000 = 33%. On sales of 1,400,000, free cash flow was under 3%.
• The utes are most of the gap. 75,000 of equipment is 4.2 times the 18,000 of depreciation. In a year where equipment spending only matched depreciation, free cash flow would have been about 114,000 − 18,000 = 96,000.
• Customers paying slower cost 25,000. That is cash the business has earned and not yet collected. The debtor days calculator shows how late it is.
• The dividends were set on the profit, not the cash. 60,000 of dividends plus 12,000 of repayments is 33,000 more than free cash flow, so the bank fell by about that much. Fine once, after a ute year; not as a habit. How much can I pay myself covers setting drawings from cash.

Press "Load the worked example" above to see it in the calculator.

Free cash flow vs net cash flow vs profit

• Net profit counts sales when invoiced and spreads equipment over years. It says whether the work pays. The difference between them is covered in profit but no cash.
• Free cash flow is the cash the business produced after keeping its equipment going. It says what the business can afford to pay out. Divide it by net profit for your free cash flow conversion; the cash conversion ratio guide shows what a falling ratio means. It is also what a buyer values: discounted cash flow turns five years of it into a price, using the version before interest. Much of that price sits beyond year five, in the terminal value: for a cleaning company with $121,000 of free cash flow in year five, it is $175,836 of a $473,072 value, about 37%. Unlevered vs levered free cash flow shows both, and why a business with a big loan repayment can have little left for its owners.
• Net cash flow is the whole change in the bank, after loans, repayments and drawings. It says what happened. The net cash flow calculator works that out.

Finding the figures in Xero

1. Accounting › Reports › Statement of Cash Flows: "Net Cash Flows from Operating Activities" is your operating cash flow, and the investing section shows equipment bought and sold. The Xero statement of cash flows explained goes through each line.
2. Or build it from the Profit and Loss (net profit, depreciation) and two Balance Sheets a year apart (the change in accounts receivable, inventory and accounts payable). See how to read a balance sheet in Xero.
3. Xero builds the cash flow statement from what is coded to your bank accounts, so a vehicle coded as an expense, or a loan coded as income, will land in the wrong section.

How to raise free cash flow

• Collect faster. Every week off debtor days releases cash with no extra sales. How to improve cash flow ranks the levers.
• Hold less stock, and use the supplier terms you have.
• Time equipment spending. Check the cash runway before a big purchase, and consider whether finance spreads the cost better than paying cash.
• Fix the margin. Free cash flow starts with profit; the operating profit guide shows where it goes.

Questions