Software Growth

Free cash flow

Free cash flow is the cash your business generates after operating costs and capital spending. It is what you actually have left to use.

Free cash flow (FCF) is the cash left after you pay to run the business and to invest in it. It is the number that decides whether you can keep going, because bills are paid in cash, not in accounting profit. When FCF is negative, it is your burn rate, and it sets your runway.

How to calculate free cash flow

Operating cash flow is the cash from running the business, including the effect of customers who pay in advance. Capital expenditures include equipment and, in some companies, capitalized software development.

Example: your SaaS generates $60,000 of operating cash flow this year, and you spent $15,000 on capitalized development and equipment.

On $400,000 of revenue, that is an FCF margin of 11.25%.

Why SaaS cash differs from profit

Subscription timing matters. Annual plans paid up front put cash in the bank before the revenue is recognized, so FCF can be positive while the income statement shows a loss. Bessemer observes that cloud businesses often show significant positive free cash flow long before they turn GAAP EBIT positive. See deferred revenue for why.

The reverse risk is real. SaaS Capital warns that when growth slows, the cash benefit of advance billing shrinks, and a company can burn cash even while its P&L improves. A lot of FCF that came from prepayments is borrowed from future months of service.

FCF versus EBITDA

EBITDA ignores interest, taxes, working capital and capital spending. FCF includes the real cash effects of these, so it is the stricter measure. Brad Feld suggests backtesting profit measures against free cash flow, and Bessemer's efficiency score adds FCF margin to ARR growth, a close cousin of the Rule of 40.

FCF margin

For small SaaS

  • Keep a simple cash view: bank balance this month minus last month, adjusted for money you put in or took out. That is close to FCF for most small companies.
  • Put aside tax and refund money for annual customers before you call prepayments free.
  • If you pay yourself nothing, a positive FCF understates the true cost of running the business.

Common mistakes

  • Treating annual prepayments as profit.
  • Skipping capitalized development costs, which are cash even if they do not show as expenses.
  • Comparing FCF across months with very different billing timing.

Sources

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