Importance
of Free Cash flow in business:-
It is a measure of financial
performance calculated as operating cash flow minus changes in working capital.
Free cash flow is important because it allows a company to pursue opportunities
that enhance shareholders value. Without cash, it's tough to develop new
products, make acquisitions, pay dividends and reduce debt. FCF is calculated
as:Net operating profit + Depreciation & Amortization - Changes in Net
Working Capital.
While working with many well
established organizations in India as finance head specially with NHK Spring
main focus while reviewing financial performance used to be on Free cash flows.
A company may have good sales figures and profitability but by not getting realization of its Trade debtors in time may
become financially sick due to lack of funds. Stress should always be on
management of working capital and keeping it positive by low inventories and
zero bad debts. Even a small % of bad debt can wipe out profitability of any
business overnight as many companies operate on thin profit margins due to
acute competition.
Is
negative working capital bad?
Answer
is NO
A company operating with
negative working capital ((e.g.In fast food chains like Dominos, KFC,
McDonalds, Indian Haldiram etc etc where payments are realized prior to
supplies to customers (means zero debtors) but enjoying good credit period from
suppliers)) perform much better than a company with high current ratio and high
profitability but a negative free cash flow on account of its failure to
realize its debtors in time and slow inventories turnover.
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