A new book illustrates the ‘golden rule’ of free cash flow to keep businesses financially healthy

Free cash flow determines a company’s health and financial fitness. If one thinks of a company (or a castle) as though it functioned like the human body, then cash flow would be the company’s lifeblood. Blood flows through the human body, carrying oxygen and nutrients to organs that help maintain bodily functions. When the body is starved of blood, bad things happen. The same is true with cash and a company. When a business is starved of healthy cash flow, it is difficult to invest in the company’s growth.

The important thing to remember is that free cash flow depends on several business parameters, such as revenue, gross margin, operating expenses (OPEX), capital expenses (CAPEX), working capital, debt repayments, interest payments, and taxes.

A general manager’s goal is to optimise these different parameters to maximise the resultant free cash flow. Since free cash flow is dependent on these parameters, it is a diagnostic indicator of how a business is managed. This is the reason I use it as my key indicator of the health and strength of a company.

In summary, free cash flow is a measure of financial fitness because it funds day-to-day operations, gives investors the confidence to lend the company...

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