Free cash flow is the cash your company's trading generates after paying its running costs and investing in equipment, vehicles, and other long-term assets. The formula is operating cash flow, minus capital expenditure. For a limited company director, this money can be used for things like investing in growing the business, planning for quieter periods, paying off debt, paying dividends, or building up savings.

In iwoca's survey of 1,005 small business owners (April 2026), 60% said more money goes out than comes in for at least half of the year. Free cash flow over a full year shows whether trading still leaves cash spare once those uneven months and any investment are added up.

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The free cash flow formula

To calculate your free cash flow you need to first know your operating cash flow and your capital expenditure. Operating cash flow is the cash your trading brings in after paying day-to-day costs, and capital expenditure is what you spend on assets you'll use for more than a year, such as machinery, vans, or computers.

Free cash flow = operating cash flow − capital expenditure

Free cash flow is often shortened to FCF, and capital expenditure to capex. On a cash flow statement, look for the line called ‘net cash from operating activities’. This shows how much cash the business generates from its day-to-day activities. Capex is usually listed under ‘investing activities’. It includes money spent buying things the business will use over the long term, such as property, machinery, equipment and software.

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How to calculate free cash flow from your accounts

You can work out free cash flow from your profit and loss account and the balance sheets for this year and last, in four steps. The result is a close estimate of the figure a full cash flow statement would give you.

1. Start with net profit after tax, from your profit and loss account.
2. Add back depreciation and amortisation. These costs spread the price of an asset over its useful life, so no cash leaves the business when they're charged.
3. Adjust for working capital, the cash tied up in running the business day to day. Subtract any increase in what customers owe you and in the stock you hold, and add any increase in what you owe suppliers. Do the opposite for any that fell.
4. Subtract capital expenditure: what you paid during the year for equipment, vehicles, property, or software you'll use for more than a year.

Steps 1 to 3 give you operating cash flow, and step 4 turns it into free cash flow.

Many small companies don't have a cash flow statement to read from, because companies preparing small company accounts under FRS 102 Section 1A don't have to include one. For financial years starting on or after 6 April 2025, a company is usually small if it meets two of these: turnover up to £15m, a balance sheet total up to £7.5m, and 50 or fewer employees. If that's your company, the four steps work from the accounts you already have, and many accounting packages can also produce a cash flow report.

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Free cash flow example for a small limited company

A company with £60,000 of net profit can end the year with £15,000 of free cash flow once unpaid invoices, extra stock, and a £40,000 equipment purchase are counted. The figures below are illustrative.

Profit of £60,000 has become £15,000 of free cash flow. Two things explain the gap: £20,000 tied up in working capital, and the £40,000 spent on equipment, which the profit and loss account spreads over several years as depreciation.

Unpaid invoices are often the biggest part of that working capital drag. iwoca's April 2026 survey found the average UK small business is owed £22,000 in payments, and every pound of it counts as profit before it counts as cash.

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How free cash flow differs from profit, EBITDA and net cash flow

Free cash flow counts cash when it actually moves, so it can be much lower or higher than profit in the same year. EBITDA isn't the same as free cash flow either: it leaves out tax, working capital, and investment, and all three use cash.

Each measure below answers a different question, and the last column shows what it doesn't tell you:

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Free cash flow doesn't include financing

Free cash flow is measured before financing, so new loans, loan repayments, dividends, and money raised by issuing shares all sit outside it. That's the point of the figure: it shows the cash available to pay for those things.

Interest is the one grey area. Depending on how your accounts are prepared, interest paid can appear under operating activities, where it's already inside operating cash flow, or under financing activities.

Whatever is left after capital expenditure can go towards repaying borrowing, paying dividends, investing in growth, or building a cash reserve.

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What free cash flow tells a limited company director

Free cash flow shows whether your company pays its own way after investing. For a limited company director, that feeds into three decisions: paying dividends, setting money aside for Corporation Tax, and borrowing.

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Dividends need profits and cash

A company can only pay dividends out of profits available for distribution, under section 830 of the Companies Act 2006: broadly, its accumulated realised profits minus its accumulated realised losses. Free cash flow answers a separate, practical question: whether the cash is there to pay a dividend without leaving the business short for wages, suppliers, and tax. Your accountant can confirm what's distributable before you declare one.

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Corporation Tax is paid the year after

Most limited companies pay Corporation Tax nine months and one day after the end of their accounting period, so the bill for a strong year usually leaves the bank in the following year. Setting part of each year's free cash flow aside for it avoids a squeeze when it falls due. Companies with profits over £1.5m pay in instalments instead.

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Lenders look at the cash your business generates

When you apply for a business loan, lenders generally want to see that the cash your business generates can cover the repayments on top of what you already pay out. Steady or growing free cash flow helps that case. If there's a recent dip with a clear reason, such as a one-off equipment purchase, it's worth explaining it in your application.

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What is a good free cash flow?

A good free cash flow is one that stays positive and steady, or grows, over several years, rather than one particular number. Comparing it with your own turnover and past years usually tells you more than comparing it with other businesses.

Free cash flow margin makes that comparison easier: divide free cash flow by turnover, and track the percentage year on year. Businesses that spend heavily on equipment, such as manufacturers, tend to have lower free cash flow relative to turnover than service businesses, so a lower margin isn't automatically a problem.

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Negative free cash flow isn't always a warning sign

Negative free cash flow means your company spent more cash on running and investing than its trading brought in. In a year you buy a big asset, that can be planned. When operating cash flow is negative too, or free cash flow stays negative year after year, it's worth acting on.

Take the example company again. If it had bought an £80,000 machine instead of £40,000 of equipment, its free cash flow would be −£25,000 for the year, even though its trading was just as healthy.

A negative year draws on the cash the business already holds. iwoca's April 2026 survey found that 28% of small businesses have two months or less of cash in reserve, so it's worth checking how long yours would last before a big purchase, and whether paying outright or spreading the cost suits you better.

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Ways to improve free cash flow

Most of the levers sit in working capital and in the timing of investment:

• Invoice promptly and chase overdue payments, so money owed turns into cash sooner.
• Review how much stock you hold against what you expect to sell.
• Ask suppliers for longer payment terms, where the relationship allows it.
• Spread the cost of large assets, for example with asset finance or hire purchase, so the cash doesn't all go out in one year.
• Forecast your cash flow month by month, so you can see a dip before it arrives.

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When an iwoca Flexi-Loan can cover a temporary gap

Borrowing can help cover a temporary cash shortfall when you expect money to come in later. For example, you might need to buy stock ahead of a busy season or pay for a large order before your customer pays you. You’ll then need to use future free cash flow to repay the loan and cover the interest.

An iwoca Flexi-Loan is a business loan with flexible repayment options for UK limited companies. You can borrow from £1,000 to £1m and repay early with no fee, which reduces the interest you pay. Every Flexi-Loan needs a personal guarantee from at least one director.

A loan doesn't change what your trading generates, so it fits a gap with a clear end better than free cash flow that's negative because trading doesn't cover its costs. Chris Billingham, founder of Muscle Squad, an online fitness equipment business, borrows in step with his sales cycle: 'We go through waves of borrowing a significant amount and paying back a significant amount. You need the conviction that a good period is only around the corner.'

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Other versions of free cash flow

Investors and analysts use two variations: free cash flow to the firm, also called unlevered free cash flow, and free cash flow to equity, also called levered free cash flow. The difference is whether interest and debt repayments have been taken off.

Neither version deducts dividends, and both add back non-cash costs such as depreciation:

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How do you calculate free cash flow yield?

Free cash flow yield is free cash flow per share divided by the share price, shown as a percentage. It only works for companies whose shares have a market price, so for most private limited companies, free cash flow as a share of turnover is the more useful comparison.