Is there such a thing as free cash?

Is there such a thing as free cash?

The more entrepreneurs I work with, the more I appreciate that cash flow – or rather lack of it - is the issue most likely to have them awake at night staring at the ceiling.

Having cash flow issues is similar to the feeling when I drive a car forward with the handbrake on. There’s movement, but it feels very restricted and it takes a moment to realise what’s going on.

You might think that the easiest way to get cash flowing again is an injection of funds from a lender or investor. But this is a short term fix and may not get you where you need to be.

The place you need to be is the “free cash” zone. It’s the place your business gets to when it can generate a cash surplus internally without going cap-in-hand to a lender or investor, and there is a very simple tool for measuring this.

It’s called the "Cash Power Ratio".

Like any financial ratio, Cash Power has an anchor and in this case it’s revenue. You are comparing two things against the anchor: net profit and trade capital.

Relative to revenue, if net profit is the higher number, you are in the free cash zone. What this means is your business is continually generating a cash surplus.

If trade capital is the higher number, you are out of the free cash zone. What this means is that you are constantly waiting for cash reserves to accumulate before you can invest in growth.

When you have a cash surplus, the first thing you should do with it is pay down debt and pay taxes, because these things are like the handbrake on your car.

After you have paid down debt and brought taxation up to date, you really are free as a bird to spend your cash surplus in any way you see fit.