3 ms·

Finance beginner beginner here: what is actually free cash flow?

hansvm 5y ago
How much _profit_ are you making _right now_. The key point is that timing of expenses vs revenue significantly impacts cash flow. A growing business can lose money on every sale and quite literally make it up in (acceleration of) volume till they grow large/efficient enough to have profitable unit economics. For a brief example to hopefully illustrate why that matter, a pretty basic business would be to buy stuff, make a thing, and sell your widgets. If it takes you 6mo to turn every $1 into $1.30 in that business then you have pretty amazing unit economics but still might struggle with cash flow; if sales just double in a given year or two you won't have enough velocity of money to build the things people are buying without additional investments or cash reserves. Contrast that with a net-60 payment for your materials and a 30-day pre-order for your hyped up widgets. At any given point in time you'll have exactly (not actually exactly I don't think, I'd have to do the math, this might depend on how fast sales increase or decrease) twice as much money in the bank (because it's tied up in other people's accounts for a total of half the time) and a high enough velocity of money to nearly triple your sales every year (supposing you can find buyers for your product). Additional money in the bank can have super-linear value for because of the extra options available. If you're struggling to pay rent and wages this month and a great deal on the lathe you need crops up then you might quite literally not be able to take advantage of that cheaper machine at the moment and be forced to pay more later when you can actually afford it. Or if you're able to efficiently utilize cash to grow your business you can just use those cash reserves to grow more quickly. In any case, cash flow is typically a good thing to have. That isn't to say that profits and whatnot don't matter (especially on sufficiently large timescales), but they don't impact the day-to-day functioning of the business directly like cash flow does.

How much _profit_ are you making _right now_. The key point is that timing of expenses vs revenue significantly impacts cash flow. A growing business can lose money on every sale and quite literally make it up in (acceleration of) volume till they grow large/efficient enough to have profitable unit economics. For a brief example to hopefully illustrate why that matter, a pretty basic business would be to buy stuff, make a thing, and sell your widgets. If it takes you 6mo to turn every $1 into $1.30 in that business then you have pretty amazing unit economics but still might struggle with cash flow; if sales just double in a given year or two you won't have enough velocity of money to build the things people are buying without additional investments or cash reserves. Contrast that with a net-60 payment for your materials and a 30-day pre-order for your hyped up widgets. At any given point in time you'll have exactly (not actually exactly I don't think, I'd have to do the math, this might depend on how fast sales increase or decrease) twice as much money in the bank (because it's tied up in other people's accounts for a total of half the time) and a high enough velocity of money to nearly triple your sales every year (supposing you can find buyers for your product). Additional money in the bank can have super-linear value for because of the extra options available. If you're struggling to pay rent and wages this month and a great deal on the lathe you need crops up then you might quite literally not be able to take advantage of that cheaper machine at the moment and be forced to pay more later when you can actually afford it. Or if you're able to efficiently utilize cash to grow your business you can just use those cash reserves to grow more quickly. In any case, cash flow is typically a good thing to have. That isn't to say that profits and whatnot don't matter (especially on sufficiently large timescales), but they don't impact the day-to-day functioning of the business directly like cash flow does.