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Tuesday, April 19, 2016

FREE CASH FLOW-AN ELIXIR FOR BUSINESS



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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