How To Use The Free Cash Flow Ratio
- To purchase new equipment that will benefit your business
- To expand your business
- Purchasing inventory
- Hiring and training employees
If you can afford to take on a loan, the extra funds may be just what your business needs to succeed. Use the cash flow of financing activities to analyze your business’s financial state and determine what is healthiest for your future.
The free cash flow ratio is one of the most important ratios a business owner should know. While the cash flow statement shows your overall net cash flow, the free cash flow ratio shows the amount of cash that is actually available for your business to use. This ratio is incredibly important for analyzing your business’s financial health.
Free cash flow shows you the amount of the cash left over after paying for your business’s operating expenses (the expenses required to run your business) and capital expenditures (the expenses spent on purchasing and maintaining your fixed assets). You can calculate your free cash flow by using this formula:
Simply take the net operating cash flow from your cash flow statement and subtract the total capital expenditures for your business.
By using this formula, you can see exactly how much free cash flow your company has to work with. Free cash flow is particularly important when considering taking on a new working capital loan to expand your business. Knowing exactly how much money you have in free cash, on average, can help you determine the loan payments you can afford.
How To Create A Cash Flow Forecast
Another important step in analyzing your business’s cash flow – and, in turn, your business’s health – is to create a cash flow forecast.
A cash flow forecast, also known as a cash flow projection, is an estimation of your future cash inflows and cash outflows over a specific period of time (usually a year). This estimation should be based on past cash flow data or educated guesses on the cash sales and expenses you expect to face in the upcoming year. This helps your cash flow projection to be as accurate as possible.
While cash flow forecasts are beneficial for any business wanting to get a handle on its finances, they are particularly helpful for seasonal businesses. A cash flow forecast can help you pinpoint the months during which cash will be tight and the months during which cash will be plentiful. This way, you can plan to save enough cash to cover expenses during the slow months.
In this way, a cash flow forecast gives you valuable business insight. Additionally, comparing your cash flow projection with your cash flow actuals at the end of the year is an important business practice for seeing if you met your business goals, 
where your company is excelling, and where it could still improve.
Many accounting software programs have a cash flow forecast report built-in. However, if your accounting software doesn’t have a cash flow projection, you can create one manually by estimating your:
- Cash sales for each month
- Expenses for each month
- Fixed asset investments
- Debt payments
- Additional capital
Be as realistic as you can and include any sales or expenses that directly affect your business’s cash. If you don’t want to calculate this all by hand, there are several free cash flow forecast templates available online as well.
Analyzing Business Cash Flow FAQs
Cash flow analysis gives you a good view of how much money your business is bringing in, as well as where money is being spent. You can use cash flow analysis to determine the financial health of your business. Cash flow analysis can help you see where you need to cut expenses, shows periods throughout the year when cash flow declines, and helps you determine if you need to increase cash flow through ramping up sales or even taking out a small business loan.