What is Free Cash Flow and How to Calculate It: A CFO’s Guide to Financial Health | Ambill

Understanding Free Cash Flow: A Key to Financial Health

For CFOs and finance professionals, understanding free cash flow (FCF) is critical to assessing a company’s financial health and making informed decisions. Free cash flow is a key metric that reveals how much cash a business generates after accounting for the capital expenditures required to maintain or expand its operations. It’s the cash available for reinvestment, debt repayment, or distribution to shareholders.

In this blog, we’ll explore:

What free cash flow is and why it matters.
How to calculate free cash flow step by step.
How Ambill.ai can help improve free cash flow by optimizing accounts receivable (AR) processes.

What is Free Cash Flow (FCF)?

Free cash flow (FCF) measures the cash a company generates from its operations after deducting capital expenditures (CapEx)—the funds spent on maintaining or expanding its asset base. It’s a measure of financial flexibility and a key indicator of a company’s ability to:

Invest in growth opportunities (e.g., new projects, acquisitions, or R&D).
Pay dividends to shareholders.
Reduce debt and strengthen the balance sheet.
Navigate economic downturns or unexpected challenges.

For SaaS companies, where recurring revenue and cash flow predictability are crucial, free cash flow is an essential metric for long-term sustainability.

Why is Free Cash Flow Important?

Free cash flow is often considered the lifeblood of a business. Here’s why it matters:

Growth and Investment: Positive FCF enables companies to invest in growth initiatives without relying on external financing.
Shareholder Value: Companies with strong FCF can reward shareholders through dividends or share buybacks.
Debt Management: Excess cash can be used to pay down debt, reducing interest expenses and improving financial stability.
Operational Resilience: A healthy FCF ensures a company can weather economic uncertainties and maintain operations during tough times.

According to financial experts, companies with consistent positive free cash flow are better positioned for long-term success.

How to Calculate Free Cash Flow

There are multiple ways to calculate FCF, but one of the most common and straightforward formulas is:
$$ {Free Cash Flow (FCF)} = {Operating Cash Flow (OCF)} - {Capital Expenditures (CapEx)} $$

Let’s break it down step by step:

Calculate Operating Cash Flow (OCF)
- Operating cash flow represents the cash generated from core business operations. It can be calculated using the following formula:
  $$ {Operating Cash Flow} = {Net Income} + {Non-Cash Expenses} + {Changes in Working Capital} $$
- Net Income: Found on the income statement.
- Non-Cash Expenses: Includes depreciation, amortization, and stock-based compensation.
- Changes in Working Capital: Reflects changes in current assets and liabilities (e.g., accounts receivable, inventory, accounts payable).
Identify Capital Expenditures (CapEx)
- Capital expenditures are the funds spent on acquiring or maintaining physical assets like property, plant, and equipment (PP&E). CapEx is typically listed in the investing activities section of the cash flow statement.
Subtract CapEx from Operating Cash Flow
- Once you have the operating cash flow and capital expenditures, subtract CapEx from OCF to determine free cash flow.

Example Calculation

Let’s consider a hypothetical SaaS company with the following financial data:

Net Income: $500,000
Depreciation: $50,000
Changes in Working Capital: -$20,000 (indicating an increase in working capital)
Capital Expenditures (CapEx): $100,000

Step 1: Calculate Operating Cash Flow
$$ {Operating Cash Flow} = 500,000 + 50,000 - 20,000 = 530,000 $$

Step 2: Subtract Capital Expenditures
$$ {Free Cash Flow} = 530,000 - 100,000 = 430,000 $$

In this example, the company has a free cash flow of $430,000, indicating it has sufficient cash to reinvest in growth, pay dividends, or reduce debt.

How Ambill.ai Improves Free Cash Flow

For SaaS companies, optimizing accounts receivable (AR) processes is a powerful way to improve free cash flow. Manual AR processes often lead to delayed payments, high Days Sales Outstanding (DSO), and cash flow bottlenecks. Ambill.ai, a leading AR automation platform, helps businesses streamline AR operations and unlock cash flow potential.

Here’s how Ambill.ai can help:

Automated Invoicing: Generate and send invoices automatically, ensuring timely billing and faster payments.
Online Payment Portals: Provide customers with convenient payment options to accelerate collections.
Proactive Payment Reminders: Automate reminders for overdue invoices, reducing DSO and improving cash flow.
Real-Time Reporting: Gain visibility into receivables and cash flow trends to make data-driven decisions.

By automating these processes, Ambill.ai helps reduce Days Sales Outstanding (DSO), accelerating cash inflow and improving overall financial health.

For example, a SaaS company using Ambill.ai reduced its DSO by 25%, freeing up working capital and significantly improving free cash flow.

Conclusion: Unlock Your Cash Flow Potential with Ambill.ai

Free cash flow is a critical metric for assessing a company’s financial health and operational efficiency. By understanding and optimizing FCF, CFOs can make informed decisions about growth, debt management, and shareholder value.

For SaaS companies, improving free cash flow starts with streamlining accounts receivable processes. Ambill.ai empowers businesses to automate AR operations, reduce DSO, and unlock cash flow potential.

Ready to transform your AR processes and boost free cash flow? Contact Ambill.ai today to learn how our platform can help your business thrive.