Business free cash flow: calculating it and why banks assess it
A company may report profit and regular revenue yet lack cash. Lenders assess both results and cash remaining after mandatory costs that can repay borrowing.
Free cash flow measures cash remaining after operating payments, taxes, working capital investment and necessary capital expenditure.
A stable surplus makes repayment clearer. Banks have no single universal formula and may apply their own adjustments.
What is free cash flow?
Cash generated after funding current operations and the investment needed to maintain the business.
Unlike revenue, it reflects payments; unlike accounting profit, it reflects cash movements rather than only recognised income and expenses.
The surplus may fund:
- loan repayments;
- interest;
- owner dividends;
- expansion;
- cash reserves;
- new investment;
- early debt repayment.
The business can fund obligations, reserves or some development internally.
Reserves, borrowing, supplier terms or a revised financial cycle are needed.
A branch, equipment, inventory growth or a major contract may explain it. Assess the cause, duration and funding source.
Why profit differs from cash flow
Revenue may be recognised upon delivery under accounting rules although the buyer pays 30, 60 or 90 days later.
Meanwhile the company may have paid:
- goods or raw materials;
- payroll;
- rent;
- logistics;
- taxes;
- loan interest;
- the next purchase.
The profit and loss statement may show profit while the bank account lacks cash.
| Measure | What it shows | What it does not show |
|---|---|---|
| Revenue | Value of goods, work or services sold | Cash collected and remaining after costs |
| Net profit | Result after recognised expenses | Actual receipt, payment and debt repayment dates |
| Account balance | Cash at a point in time | Mandatory payments due shortly |
| Operating cash flow | Cash from core activity after operating outflows | All required investment and capital spending |
| Free cash flow | Surplus after necessary operating and investment costs | Automatic approval without assessing receipt quality |
Simple example
A company delivers RUB 5 million of goods on 60-day terms. Goods cost RUB 3.5 million, so accounting profit may arise.
Suppliers, wages and taxes are already paid, but the RUB 5 million arrives only two months later.
Banks therefore compare profit, cash flow reports, bank statements, receivables and mandatory payments.
Cash flow types to distinguish
Cash flow statements usually group receipts and payments into three categories.
Revenue, suppliers, payroll, rent, taxes and current costs.
Purchases and sales of equipment, property and other long-term assets.
Borrowing, debt repayment and owner contributions.
Surplus after operations and necessary capital investment.
Adjusted cash available for principal and interest.
Investors may calculate cash for the firm, owners dividend capacity and banks cash available for debt service.
Calculating free cash flow
Method 1. Direct management calculation
SMEs can start with actual cash movements.
For bank purposes, identify one-off receipts, owner expenses, internal transfers and existing loan payments separately.
Method 2. From operating cash flow
Capital spending includes equipment, vehicles, property, software and other long-term assets.
Method 3. From operating profit
This is common in financial analysis and valuation. Reconcile credit application calculations with actual bank statements and management cash flow reports.
Some costs relate to goods already sold, others create inventory, while equipment has a different economic nature. Without classification, calculations become distorted.
What is a working capital change?
Growing businesses often put funds into inventory and receivables, so revenue growth does not always raise free cash flow.
Cash may be tied up in:
- unpaid receivables;
- stock;
- raw materials and supplies;
- work in progress;
- supplier advances;
- contract security;
- deposits and minimum balances.
Overdue supplier debts are not a normal financing source.
Free cash flow calculation example
Illustrative annual figures
For this management model, the separately shown RUB 2 million working capital commitment is assumed not to be included already in receipts or operating payments. Otherwise omit that extra deduction. Free cash flow before owner payments is:
After owner payments, RUB 6.5 million remains.
If existing debt service is RUB 3 million annually, RUB 3.5 million remains afterwards.
Banks assess whether additional payments can be met without a permanent deficit.
Why banks analyse free cash flow
Loans need a clear, sustainable repayment source. Security reduces risk but does not replace regular payment capacity.
Cash flow analysis answers several questions.
Surplus after costs for a new loan payment.
Recurring performance or one large transaction.
Months when receipts cannot cover payments.
Operations, a contract, asset sale or new borrowing.
Loan size versus actual debt-service capacity.
Payments aligned with revenue and the operating cycle.
Positive annual cash flow can hide months of deep shortfalls. Monthly trends matter.
Items banks may exclude or adjust
Management calculations may be changed for one-off, unsupported or unsustainable receipts and costs.
| Measure | Potential adjustment | Reason |
|---|---|---|
| Own-account transfers | Excluded from receipts | Not new revenue |
| Owner contributions | Separated from operating flows | Not generated by core activity |
| New borrowing | Not treated as business income | Creates a repayment obligation |
| Property or equipment sales | Treated as one-off receipts | Not recurring |
| Unverified cash sales | May be excluded or partly counted | Source cannot be reliably checked |
| Owner personal expenses | Treated as actual outflows | Reduce cash available to the business |
| One-off payment savings | Normalised | Costs may recur next period |
| Overdue payables | Treated as future payments | Cash remains temporarily but the obligation persists |
| Receivables | Assessed by timing and buyer quality | Not all receivables become cash on time |
Moving the same funds repeatedly between banks makes gross credits exceed actual revenue.
Cash flow and debt coverage
Banks compare adjusted cash with payments on existing and requested obligations.
Numerator, period and acceptable ratio depend on the bank’s methodology and product.
Above one means calculated cash exceeds debt service.
A small buffer may be insufficient with seasonality, customer concentration, unstable prices or long payment terms.
Debt should remain serviceable with moderate revenue decline or cost increases, not only under ideal conditions.
Which period to use
For an initial assessment, prepare:
- at least the last 12 months’ actual data;
- monthly calculations, not only annual totals;
- the comparable previous-year period;
- a forecast over the proposed loan term;
- a revenue decline scenario;
- existing and future debt payment schedules.
One quarter rarely represents a seasonal business. Peak receipts can hide shortfalls elsewhere.
Documents for the bank
Monthly receipts and payments by activity.
Revenue, cost of sales, expenses and profit.
Inventory, receivables, payables, cash and debt.
Actual turnover across all business accounts.
Buyers, amounts, due dates and arrears.
Suppliers, deadlines and overdue obligations.
Balances, rates, schedules and security.
Evidence of future revenue and payment timing.
Equipment, vehicle and other asset purchases.
Future receipts, mandatory payments and proposed borrowing.
Preparing a credit application calculation
Cover the entire business cash flow, not just the main bank.
Exclude own-account movements and repayments of previously advanced funds.
Show borrowing, owner contributions and asset sales separately.
Include changes in inventory, receivables and payables only where not already reflected in cash receipts/payments.
Separate necessary asset replacement from optional expansion.
Show principal, interest, leasing and other recurring obligations.
Compare it with free cash flow and seasonal lows.
Test lower revenue, higher costs or delayed receivables.
Common calculation mistakes
Some cash is already committed to taxes, payroll and suppliers.
Profit does not show customer payment dates or actual cash movements.
A loan raises cash and debt together.
The same rouble enters gross turnover repeatedly.
Revenue rises but buyers have not paid.
An apparent surplus includes funds needed for taxes.
Averages hide seasonal gaps.
Regular owner payments reduce cash available for debt.
Overdue suppliers must be paid despite temporarily supporting cash.
A small disruption may make payments impossible.
When positive cash flow may not persuade a bank
A positive result does not guarantee approval. Banks assess source quality and resilience.
Further questions arise when:
- one buyer generates most revenue;
- receipts are irregular;
- owners supplied much of the cash;
- receivables are overdue;
- margins are falling rapidly;
- suppliers require advances;
- taxes or loans are overdue;
- asset sales produced the surplus;
- major mandatory investment is planned;
- the new payment consumes almost all free cash flow.
Keep reserves for seasonality, cost increases, late customers and unexpected payments.
Improving free cash flow
Review terms, limits and arrears control, and consider factoring.
Separate fast- and slow-moving goods and adjust purchasing.
Align purchases with customer receipts.
Avoid sales that raise turnover but consume cash.
Identify payments unrelated to revenue generation.
Distinguish essential replacement from deferrable investment.
Consider a better term, facility, seasonal schedule or refinancing.
Forecast balances and gaps before payments fall due.
Faster receivables collection, less stock, revised purchasing and suitable banking products may have greater impact.
When to seek help
Assessment helps profitable companies with recurring shortages or reduced bank limits.
Help is particularly relevant when:
- bank statements and management accounts disagree;
- turnover is spread across banks;
- seasonality is strong;
- receivables are substantial;
- several loans run simultaneously;
- a prudent payment amount is needed;
- an RCF or working capital loan is required;
- a bank rejected a weak repayment source;
- a financial model is needed;
- a major contract or investment is planned.
Calculate actual debt-service capacity
NG Finance helps Russian LLCs and individual entrepreneurs reconcile management cash flow, account turnover, debt, receivables and proposed repayment schedules.
Analysis does not guarantee approval, but helps identify a realistic limit, weaknesses and clear repayment sources.
Submit a requestFrequently asked questions
Are free cash flow and net profit the same?
No. Net profit is an accounting result; free cash flow reflects receipts and payments, working capital and capital spending.
Can it be calculated from a bank statement alone?
Statements show actual movements but need classification. Separate transfers, borrowing, owner contributions and one-off receipts from operations.
Why can a profitable business have negative cash flow?
Funds may be tied up in receivables, inventory, equipment, supplier advances or past obligations.
What is a good free cash flow?
There is no universal amount. It should be stable, evidenced and cover existing and new debt with sufficient headroom.
Do banks count owner funds?
Contributions may evidence support but are generally separated from cash generated by core activity.
Should an entrepreneur’s personal withdrawals be included?
Yes. Regular withdrawals reduce business cash available for obligations.
How does seasonality affect the calculation?
Positive annual totals may include deficit months. Compare monthly cash flow with loan timing.
Is a new loan cash flow?
It increases cash but is financing activity and creates debt. It is not operating income.
Which matters more: collateral or cash flow?
Security reduces potential loss, but business cash flow is generally the normal repayment source. The approach depends on product and methodology.
Can better calculations raise a credit limit?
Clear reporting helps assessment, but debt, turnover, credit history, security and internal lender requirements also matter.
This article provides general information. Cash flow definitions, adjustments, coverage, limits and decisions depend on each bank’s methodology. Prepared using public sources: IAS 7 Statement of Cash Flows , IFRS for SMEs: Statement of Cash Flows , Bank of Russia: guidance on Regulation No. 590-P , VTB: business financial models , SberBusiness: repayment capacity indicators .