What is Free Cash Flow?
Free Cash Flow is a way of measuring a company’s financial performance. In essence, Free Cash Flow is the amount of money a company or firm can generate after spending the money they must in order to maintain and/or expand its assets. FCF is important because it tells companies – and shareholders – how much money could be dispersed to those shareholders, if no further growth occurred.
Free Cash Flow is the money leftover once a company has paid for its buildings, equipment and so on. This is the money that can then be used to pursue new investments, create new products, pay off debts and purchase new acquisitions.
Three Methods for Calculating Free Cash Flow
There are three formulas that companies can use to calculate their Free Cash Flow. We’ll take a look at them here, from the most complex down to the simplest one.
FCF = EBIAT + Depreciation and/or Amortization – Required Investments in Operating Capital
Earnings Before Interest After Taxes plus any depreciation and/or amortization, minus the company’s required investments in their operating capital equals the FCF. This is a bit of a complex way to go about calculating FCF, but all of the information should be available via the business’ income statement.
FCF = NOPAT – Net Investment in Operating Capital
Net Operating Profit After Taxes minus the net investment a company makes into its operating capital equals the FCF in this equation. This one operates using the same numbers as the previous equation, just phrased differently.
FCF = Net Cash Flow from Operations – CapEx
This is the simplest way to calculate a company’s FCF. The net cash flow from operations minus the capital expenditures equals the FCF. You can find the CapEx by looking at the increase in fixed assets on a balance sheet, and find the net cash flow from operations on the company’s cash flow statement.
Overall, these three equations reach the same answer, just using slightly different methods. Whichever you opt to use, the information needed should be available to you via your balance sheet, income statements and cash flow statements. Knowing the FCF is important to knowing how quickly and how much your company can expand. Keeping tabs on what your business’ FCF is will help you better use your resources.
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