The next component of Free Cash Flow is important, yet typically overlooked: Non-Cash Net Working Capital
It is a mouthful, but incredibly important.
Non-cash net working capital is the cash you have tied up in your current operations.
Specifically…
Accounts Receivable. If you have more, you are making your customers a loan, and it ties up cash.
Inventory. If inventory increases, you are making an investment, tying up cash.
Accounts Payable. If accounts payable decrease, you are paying back unauthorized loans to suppliers, and that takes cash.
And vice-versa.
The important thing to understand is that, typically, these things change without much notice.
That is, until they become problematic.
And that problem impacts free cash flow.
Always important to be watching these as frequently as your income statement and balance sheet.
And consider some strategic questions.
- Are we providing customers too much credit? Not enough?
- Do we have too much inventory? Not enough? Do we have proper inventory controls? Quality assurance? Is shrinkage an issue?
- Are we taking advantage of cash discounts on payables? Are bookkeeping errors impacting us? Should we review our buying processes?
Your turn.
Now go spark that revolution.