The cash left after making investments in capital assets Show
What is a Free Cash Flow?Free cash flow (FCF) measures a company’s financial performance. It shows the cash that a company can produce after deducting the purchase of assets such as property, equipment, and other major investments from its operating cash flow. In other words, FCF measures a company’s ability to produce what investors care most about: cash that’s available to be distributed in a discretionary way. Types of Free Cash FlowWhen someone refers to FCF, it is not always clear what they mean. There are several different metrics that people could be referring to. The most common types include:
To learn more about the various types, see our ultimate cash flow guide.  Importance of Free Cash FlowKnowing the company’s free cash flow enables management to decide on future ventures that would improve the shareholder value. Additionally, having an abundant FCF indicates that a company is capable of paying its monthly dues. Companies can also use their FCF to expand business operations or pursue other short-term investments. Compared to earnings per se, free cash flow is more transparent in showing the company’s potential to produce cash and profits. Meanwhile, other entities looking to invest may likely consider companies that have a healthy free cash flow because of a promising future. Couple this with a low-valued share price, investors can generally make good investments with companies that have high FCF. Other investors greatly consider FCF compared to other measures because it also serves as an important basis for stock pricing. How is FCF Calculated?There are various ways to compute for FCF, although they should all give the same results. The formula below is a simple and the most commonly used formula for levered free cash flow: Free Cash Flow = Operating Cash Flow (CFO) – Capital Expenditures Most information needed to compute a company’s FCF is on the cash flow statement. As an example, let Company A have $22 million dollars of cash from its business operations and $6.5 million dollars used for capital expenditures, net of changes in working capital. Company A’s FCF is then computed as: FCF = $22 – $6.5 = $15.5m Download the Free TemplateEnter your name and email in the form below and download the free template now! FCF TemplateDownload the free Excel template now to advance your finance knowledge! Limitations Associated with Free Cash FlowThe company’s net income greatly affects a company’s free cash flow because it also influences a company’s ability to generate cash from operations. As such, other activities (i.e., those not within the core business operations of a company) from which the company generates income must be scrutinized deeply in order to reflect a more appropriate FCF value. On the investors’ side, they must be wary of a company’s policies that affect their declaration of FCF. For example, some companies lengthen the time to settle their debts to maintain cash or, the opposite, shortening the time they collect debts due to them. Companies also have different guidelines on which assets they declare as capital expenditures, thus affecting the computation of FCF. Applications in Financial ModelingFor professionals working in investment banking, equity research, corporate development, financial planning & analysis (FP&A), or other areas of corporate finance, it’s very important to have a solid understanding of how FCF is used in financial modeling. Discounted Cash Flow, or DCF models, are based on the premise that investors are entitled to the free cash flow of a firm, and therefore the model is based solely on the timing and the amount of those cash flows. To learn more about DCF modeling, check out CFI’s online financial modeling courses. Screenshot from CFI’s financial modeling course. Additional ResourcesThank you for reading CFI’s guide to Free Cash Flow (FCF). To keep learning and advance your career, the following resources will be helpful:
What does it mean when a company's free cash flow is negative?Negative cash flow is when a business spends more money than it makes during a specific period. A company's free cash flow shows the amount of cash it has left over after paying operating expenses. When there's no cash left over after expenses, a company has negative free cash flow.
Can a company have a negative free cash flow and still be considered successful?Though negative cash flow is not inherently bad, this financial asymmetry is not sustainable or viable for your business in most cases. Ultimately, your business needs enough money to cover operating expenses. Uncontrolled or overlooked negative cash flow can render your business unprofitable.
What does it mean when free cash flow decreases?Impact of Growth on Free Cash Flow
Free cash flow can also be impacted by the growth rate of a business. If a company is growing rapidly, then it requires a significant investment in accounts receivable and inventory, which increases its working capital investment and therefore decreases the amount of free cash flow.
Does a low or a negative cash flow necessarily indicate poor performance?Negative cash flow doesn't necessarily mean a company's financial performance was bad. There are many reasons why a business might show a profit on an income statement and still have little money in the bank.
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What does it mean when a companys free cash flow is negative in one or more years?
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