Definition
Free cash flow (FCF) is the cash left over after your business covers its operating expenses and capital expenditures (equipment, software, infrastructure). It's the money that's truly “free” — available for owner distributions, debt paydown, hiring, or saving for a rainy day.
Think of it this way: profit tells you what you earned on paper. Free cash flow tells you what actually landed in the bank that you can use.
Why It Matters
A business can be profitable and still run out of cash. This happens when profits are tied up in accounts receivable, inventory, or equipment purchases. Free cash flow strips away the accounting abstractions and answers the only question that matters: how much usable cash did we generate?
For small and mid-size businesses, FCF is the best measure of financial flexibility. Positive FCF means you have options — you can invest in growth, build a cash reserve, or take money off the table. Negative FCF means you're burning through reserves or taking on debt, even if the P&L shows a profit.
Example: A construction company earns $3M in revenue and reports $400K in profit. But they spent $350K on new equipment and their receivables grew by $200K. Their free cash flow is actually negative — they generated less cash than they spent, despite being “profitable.”
How to Calculate It
Free Cash Flow = Operating Cash Flow - Capital Expenditures
Operating cash flow starts with net income and adjusts for non-cash items (depreciation, changes in working capital). Capital expenditures are purchases of long-term assets like equipment or property.
Benchmarks
There's no universal “good” FCF number — it depends on your stage and strategy. Early-stage companies burning cash to grow will have negative FCF by design. Mature SMBs should generally target positive FCF equal to 5-15% of revenue. SaaS companies often aim for the “Rule of 40” — growth rate plus profit margin should exceed 40%, with FCF as a key component of that margin calculation.
The most important benchmark is your own trend. Three consecutive months of declining FCF — even if still positive — signals that something in your cost structure or collections process is moving the wrong direction.
Common Mistakes
- Confusing FCF with profit. A business can be profitable on the income statement while burning cash. Depreciation, receivables growth, and inventory buildup all create gaps between reported profit and actual cash generation.
- Ignoring working capital changes. If you're extending longer payment terms to win deals, your DSO rises and cash gets trapped in receivables. FCF captures this; net income doesn't.
- Treating all capex as equal. Maintenance capex (replacing a broken server) is different from growth capex (opening a second location). Some analysts separate the two to get a clearer picture of underlying cash generation.
How CentSight Helps
CentSight calculates your free cash flow by categorizing transactions from your connected accounts into operating expenses and capital expenditures automatically. You get a running FCF number that updates daily, not one you calculate manually at quarter-end. Ask “What's our free cash flow this month?” and CentSight shows you the answer with a breakdown of what's driving it.