FCF (Free cash flow): simple definition and calculation

Free cash flow is used, among other things, to make new investments, pay dividends and, more broadly, measure a company’s financial room for maneuver.

Acronym meaning Free cash flow, FCF refers to the money generated by a company after it has paid the investments necessary for its development. It measures the ability of a company to generate money to invest or to distribute dividends to shareholders. Free cash flow is the amount available once the investments necessary for the proper development of the activity and the production tool have been made. The managers of the company can then use it as they wish: to reimburse debts, pay exceptional dividends or diversify their activity … The FCF has two main functions: it measures the room for maneuver of a company and is used to calculate its value.

The interest for the investor to calculate the free cash flow of a company

Free cash flow is an interesting view for the investor to know because it is used on the one hand to measure the financial room for maneuver of a company and on the other hand to evaluate a company using the Discounted Cash Flow method or discounted future cash flows.

Calculation of free cash flow

Here’s some ways on how to calculate free cash flow:

FCF = gross operating surplus – changes in working capital requirement – corporate taxes – net investments

FCF = Cash Flow from Operating Activities (found in Statement of Cash Flows) + Interest Expenses (found in Income Statement) – Tax Shield on Interest Expense (found in Income Statement) – CAPEX (found in Statement of Cash Flows / from Investing Activities)

FCF = Net Income (found in Income Statement) + Interest Expenses (found in Income Statement) – Tax Shield on Interest Expense (found in Income Statement: Net Interest Expenses x Tax rate) – Change in [current Assets – Current Liabilities] (found in Balance Sheets) + Depreciation and Amortisation (found in Income Statement) – Capital Expenditures (found in Balance Sheets)

Free cash flow
The FCF tells us about the company’s value.
The FCF provides information on the value of the company and its potential toward investments.

FCF can be calculated by starting with Cash Flows from Operating Activities on the Statement of Cash Flows because this number will have already adjusted earnings for non-cash expenses and changes in working capital.

Negative free cash flow

See this example
Having negative free cash flow means that a business has consumed more money than it produced. But having negative free cash flow is not necessarily bad news. In particular, this may mean that the company has made large investments that could yield a lot in the future. On the other hand, if a company has negative free cash flow for several years, this is not a good sign.