Incorporate finance, free cash flow (FCF) or free cash flow to the firm (FCFF) is that portion of a company's total operating cash flow(OCF) and avoid referring to it as cash flow, which may be misleading. It is more commonly referred to as FCFF because of this.
As such, leverage is an indicator of a company's financial flexibility and is of interest to its various stakeholders.
What is free cash flow FCF
Cash Flow is the amount of money that a company has left over after spending funds to maintain its assets, pay for operational expenses, and fund any new projects.
Free cash flow, or FCF, is the income left after paying for tax obligations and payroll. By calculating this a company will know how much profit they are generating and be able to make better financial decisions. Investors can also use the number in order to evaluate a company’s finances which will aid them in making better investment decisions.
The more free cash flow a company has, the better its position is to pay debts and pursue opportunities that could enhance its business. This makes it an attractive choice for investors.
5 FCF's to takeaway:
- Free cash flow is the money a company has left over after paying its operating expenses and capital expenditures.
- The more cash a company has, the more it is able to allocate towards dividends, debt payments, and expansions.
- There are three ways to calculate free cash flow: using cash flow, using sales revenue, and using net operating profits.
- If a company has decreasing cash flow, this can be an indicator of future financial difficulty.
- These days, it's not enough to look at one key metric like free cash flow when assessing a company's financial health.
Unlevered Free Cash Flow
One measure of a company's cash flow is unlevered free cash flow, which means this number takes interest payments into account but not debt repayments. Unlevered free cash flow shows the company's available funds before considering financial obligations.
5 UFCF's to takeaway:
- The unlevered free cash flow is the amount of money a company has left over after accounting for all its financial obligations.
- Free cash flow (FCF) is money a company has left over after paying its operating expenses and capital expenditures.
- An increase in UFCF is of interest to investors because it indicates a business's ability to invest.
- UFCF can be contrasted with levered free cash flow which does not take into account obligations.
- An example of a discounted cash flow (DCF) analysis is the use of future benefits for public-sector employees in retirement or pensions.
How to calculate FCF
There are three ways to calculate free cash flow: by cash flow, sales revenue, or net operating profits.
Using Operating Cash Flow
A popular approach to calculating free cash flow is through analyzing operating cash flow, which measures a company's earnings generated by the normal day-to-day operations. To calculate FCF you'll need to subtract capital expenditure from cash flow.
The formula is:
Free Cash Flow= Cash Flow − Capital Expenditures
Using Sales Revenue
Revenues are the main focus of this metric, but by subtracting costs, you can determine a company's FCF. To calculate FCF, locate revenues within the income statement and then subtract all taxes and operating costs - such as COGS or SG&A.
Finally, subtract the required investments in operating capital from the net investment income.
To calculate:
Free Cash Flow=
Sales Revenue − (Operating Costs + Taxes) − Required Investments in Operating Capital
Required Investments in Operating Capital=
Year One Total Operating Capital − Year Two Total Operating Capital
Total Operating Capital=
Operating Working Capital + Net Plant, Property, and Equipment
(Operating Long-Term Assets)
Net Operating Working Capital=
Operating Current Assets − Operating Current Liabilities
Operating Current Assets=
Cash+Accounts Receivables+Inventory Operating Current Liabilities=
Accounts Payables+Accruals
Using Net Operating Profits
The calculation of free cash flow using net operating profits after taxes is the same as that of sales revenue, but with operating income in place.
To calculate
Cash Flow Free=
Net Operating Profit After Taxes − Net Investment in Operating Capital
Net Operating Profit After Taxes=
Operating Income × 1 - Tax Rate
Operating Income=
Gross Profits−Operating Expenses