What is Free Cash Flow? and why do we care?

Free Cash Flow is defined in a number of different ways as there is not a clearly defined term under the Generally Accepted Accounting Principles (GAAP).

I am going to attempt to explain Free Cash Flow in the best way possible but first why do we care about Free Cash Flow?

In simple terms Free Cash Flow is what is left over after a company pays all cash expenses and makes investments in capital equipment and working capital. So FCF (Free Cash Flow) is after tax cash flow available to all investors.

The way I learnt to calculate Free Cash Flow is start with the revenue and deduct all operating costs, arriving at operating profit. We then apply the tax rate to the operating profit. This gives us the net operating profit less adjusted taxes. To obtain FCF, we add back non-cash operating expenses, then deduct capital expenditures and investments in working capital.















Why do we care about FCF?

Free Cash flow is available to all claimholder’s on a business, both debt holder’s and shareholder’s. We care about Free Cash Flow because it helps us determine the value of company. Free cash flow or FCF helps us calculate the intrinsic value of a company, which we derive by calculating all future cash flows of the company minus the average cost of capital. So if you can buy the shares of a company at a discount to the intrinsic value, you are almost certain to make a profit.

I have learnt a great deal about this topic and other finance topics from the Motley Fool website and from the community boards. There is a lot of talk about Free Cash Flow at the Motley Fool website. Check out the following article on Foolish Fundamentals: Free Cash Flow.