In corporate finance, free cash flow (FCF) or free cash flow to firm (FCFF) is the amount by which a business’s operating cash flow exceeds its working capital needs and expenditures on fixed assets (known as capital expenditures). It is that portion of cash flow that can be extracted from a company and distributed to creditors and securities holders without causing issues in its operations.
Unlike earnings or net income, free cash flow is a measure of profitability that excludes the non-cash expenses of the income statement and includes spending on equipment and assets as well as changes in working capital from the balance sheet.
Free cash flow can be calculated in various ways, depending on audience and available data. A common measure is to take the earnings before interest and taxes, add depreciation and amortization, and then subtract taxes, changes in working capital and capital expenditure. Depending on the audience, a number of refinements and adjustments may also be made to try to eliminate distortions.
Free cash flow (FCF) is the cash flow available for the company to repay creditors or pay dividends and interest to investors. Some investors prefer to use FCF or FCF per share over earnings or earnings per share as a measure of profitability because these metrics remove non-cash items from the income statement. However, because FCF accounts for investments in property, plant, and equipment, it can be lumpy and uneven over time.
Because FCF accounts for changes in working capital, it can provide important insights into the value of a company and the health of its fundamental trends.
FCF is also helpful as the starting place for potential shareholders or lenders to evaluate how likely the company will be able to pay their expected dividends or interest.
While FCF is a useful tool, it is not subject to the same financial disclosure requirements as other line items in the financial statements. This is unfortunate because if you adjust for the fact that capital expenditures (CapEx) can make the metric a little “lumpy,” FCF is a good double-check on a company’s reported profitability. Although the effort is worth it, not all investors have the background knowledge or are willing to dedicate the time to calculate the number manually.
Free cash flow is an important financial metric because it represents the actual amount of cash at a company’s disposal. A company with consistently low or negative FCF might be forced into costly rounds of fundraising in an effort to remain solvent. Similarly, if a company has enough FCF to maintain its current operations, but not enough FCF to invest in growing its business, that company might eventually fall behind its competitors. For yield-oriented investors, FCF is also important for understanding the sustainability of a company’s dividend payments, as well as the likelihood of a company raising its dividends in the future.
Formula: FCF = Cash from Operations – CapEx
Cash rules everything around me. C.R.E.A.M. get the money— dollar dollar bill, yo.
