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An introduction to free cash flow
What is free cash flow?
Free cash flow is the cash that a business has available to pay debts, buy assets (such as stock or property), or pay shareholders’ dividends and interest. It doesn’t include the company’s value towards any ownership rights such as property, stock, equipment, licensing, or patent rights.
Essentially, free cash flow is the amount of money that a business can produce immediately. Although not a representation of a company’s total value, it’s a good measure of its financial performance.
Read on for tips on how to calculate it, and how you can improve your business cash flow performance.
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Why does free cash flow matter?
Free cash flow is vital for a business to expand and pursue future ventures without risking financial ruin. Based on the amount of free cash flow it has available, a business can decide to pursue short or long-term investments, pay off their debt to creditors, or pay their shareholders’ dividends.
Free cash flow formula
You can easily calculate the free cash flow available for your business with a simple formula:
Operating cash flow – capital expenditures
How to calculate free cash flow
Here’s a step-by-step guide on how to calculate the free cash flow for your company:
- Calculate the total revenue/earnings for the calendar year.
- Calculate taxes paid for that year.
- Calculate expenses for the same calendar year.
- Calculate revenue - taxes - expenses.
- The remaining total will be the free cash flow of your company at the end of the calendar year.
What is unlevered free cash flow?
Unlevered free cash flow is the amount of available cash that a business has available before accounting for its various financial obligations. This financial obligation includes paying off any debts, interest, or shareholder dividends.
What is levered free cash flow?
Levered free cash flow refers to the amount of money that a business has remaining after paying its financial obligations. It’s widely considered the most vital figure for investors to take a look at because it’s a good indicator of company profits.
How to calculate free cash flow yield?
Free cash flow yield is the financial solvency ratio of a company. You can calculate your company’s free cash flow yield by dividing its free cash flow per share by the current share price.
How to convert free cash flow to firm?
Free cash flow to firm (FCFF) shows the cash that is available to all funding providers. This may include common stakeholders, preferred stakeholders, debt holders, and more. The usual starting point when calculating FCFF is to obtain net operating profit after tax (NOPAT). All non-cash expenses are then removed, alongside capital expenditure and changes in net working capital. FCFF can also be referred to as unlevered cash flow (which we mentioned above).
Read more on cash flow:
What is a cash flow statement?
How to overcome your cash flow problems
Are you trying to improve your cash flow?
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