Free cash flow

Category:Financial analysis
Alternative names: FCF

What is Free cash flow

Free Cash Flow (FCF) is the cash that a company produce from its operations (Operating Cash Flow) less the capital expenditures (CAPEX). It’s the amount of cash flow that is available to spend by the management of the company to pay dividends, buy back shares, expand operations, and reduce debt.

How to calculate Free cash flow (formula)

There are various ways to calculate FCF but this is the most commonly used formula:

Free cash flow (FCF) = Operating Cash Flow − Capital Expenditures

The Operating Cashflow and capital expenditures figures can be found on the company’s cash flow statement.

Why is Free cash flow useful/important

Free cash flows is an important measurement since it shows how efficient a business is at generating cash. Companies use their Free Cash Flow to expand business operations, pay down debt or return capital to the shareholders. From investors side, a company with good free cash flow capacity is a sign that the company might have enough cash to return some of it to investors via dividends or share buybacks. Growing free cash flows are usually a sign to increased earnings and increased efficiency in the business. That is why many in the investment community cherish FCF as a measure of value. Conversely, shrinking FCF might signal that companies are struggling to sustain earnings growth.

Free Cash Flow is similar to Net Income in its attempt to measure the profits that the company can generate. The main difference is that Net Income is accounting measure and it includes non-cash expenses accounts like depreciation and amortisation. Free Cash Flow is a measure of the actual cash that can theoretically be distributed to owners. Most of the differences between net income and free cash flow arise where the company pay out cash to (purchase assets for example) in one period, but it is accounted for on the income statement in a different period.

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