Free Cash Flow

Free Cash Flow

A measure of a company's ability to generate the cash flow necessary to maintain operations. There is more than one way to calculate free cash flow, but perhaps the simplest is to subtract a company's capital expenditures from its cash flow from operations. Some analysts believe that free cash flow is more important than other measures of financial health because it measures how much cash a company has and can make. This differs from other measures, which are sometimes accused of using both legitimate and illegitimate forms of accounting to make a company look healthier than it really is.

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free cash flow

The cash flow that remains after taking into account all cash flows including fixed-asset acquisitions, asset sales, and working-capital expenditures. The definition of free cash flow varies depending on the purpose of the analysis for which it is being used.

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Free cash flow. A business's free cash flow statement may differ significantly from its cash flow statement. The cash flow statement generally represents earnings before interest, taxes, depreciation, and amortization (EBITDA).

Cash flow and EBITDA focus specifically on the profitability of the company's actual business operations, independent of outside factors such as debt and taxes. Free cash flow, however, reports the net movement of cash in and out of the company.

To determine free cash flow, equity analysts add up all the company's incoming cash and then subtract cash that the company is obligated to pay out, which includes all expenses, debt service, preferred dividends, and capital expenditures. The result tells you how much cash was left over or how short of cash the company was at the end of the fiscal period.

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Free Cash Flow (FCF)

What Does Free Cash Flow (FCF) Mean?

A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it is tough to develop new products, make acquisitions, pay dividends, and reduce debt. FCF is calculated as follows:

It also can be calculated by taking operating cash flow and subtracting capital expenditures.

Investopedia explains Free Cash Flow (FCF)

Some people believe that Wall Street focuses too much on earnings while ignoring the “real” cash that a firm generates. Earnings often can be clouded by accounting gimmicks, but it is tougher to fake cash flow. For this reason, some investors believe that FCF gives a much clearer view of a company's ability to grow and generate cash (and thus profits). It is important to note that negative free cash flow is not necessarily a bad thing. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.

Related Terms:
• Cash Flow Statement
• Free Cash Flow to Equity—FCFE
• Free Cash Flow Yield
• Operating Cash Flow—OCF
• Operating Cash Flow Ratio