Defining Cash from Operations
The Delta Free Cash Flow Model is our internal cash flow strategy. The model begins by dividing the cash flow into two parts, the debt service portion and the free cash flow portion. The debt service cash flow is the total of the annual debt service multiplied by a minimum requirement set out by your lender. A common requirement is a 1.2 to 1 debt service coverage ratio. This means that the first portion of the cash flow equal to 120% of the annual debt service is reserved for the lender. This cash flow cannot be used to fund operations or growth. The balance (highlighted in yellow) is the free cash flow.
The Uses of Free Cash Flow
The free cash flow is the discretionary cash flow that can be used for operations and growth. In general, the free cash flow can only be used for three things, revitalization, growth or distributions. Revitalization includes replacing old equipment, upgrading processes or extra debt payments to strengthen the company’s leverage. These expenses are usually considered efficiency or maintenance in nature. Growth expenses, which are entrepreneurial in nature, include creating new products, entering new markets and expansion of capacity to meet demand. Expenses in this category can include product or market R&D, marketing and promotion, sales and marketing, as well as investments in equipment or other assets. Distributions or Return On Investment (ROI) items are the financial reward cash outlays. These items include excess salaries, bonuses and distributions to owners. These are usually the last thing to get paid once the revitalization and growth expenses have been funded.