Free Cash Flow (FCF) is a financial metric that represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. 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.
Free Cash Flow is important because it allows a company to pursue opportunities that enhance shareholder value. For instance, with an adequate amount of FCF, a company can develop new products, make acquisitions, pay dividends to shareholders, and reduce debt.
The formula to calculate Free Cash Flow is:
Free Cash Flow = Operating Cash Flow – Capital Expenditures
Where:
– Operating Cash Flow is the cash generated from normal operations of the business.
– Capital Expenditures (CapEx) are the funds used by a company to acquire, maintain, and upgrade physical assets such as property, buildings, an industrial plant, or equipment.
It’s crucial to note that having a positive FCF doesn’t necessarily mean a company is financially healthy. Similarly, having a negative FCF isn’t inherently bad—it could be indicative of a company making significant investments in its future growth. Therefore, Free Cash Flow should be evaluated in the context of the company’s industry, growth phase, and other financial metrics.