Free Cash Flow (FCF) is the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. In simpler terms, it's the cash left over after a company pays for its day-to-day business and invests in its future growth, such as buying new equipment or buildings. This cash is available to distribute to creditors and shareholders or to reinvest in the business.

Formula

The most common formula for Free Cash Flow (FCF) is: FCF = Operating Cash Flow - Capital Expenditures.Operating Cash Flow (OCF): This represents the cash generated from a company's normal business operations before any non-operating expenses or income are accounted for. It's found on the cash flow statement and indicates how much cash the company's core business is actually bringing in.Capital Expenditures (CapEx): These are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. They are necessary investments to keep the business running and facilitate future growth.

Why is it Important for Investors?

Investors highly value Free Cash Flow because it provides a true measure of a company's financial health and operational efficiency, distinct from net income which can be influenced by non-cash accounting entries. FCF indicates a company's ability to generate cash that can be used for various purposes: paying down debt, issuing dividends, buying back shares, or funding future expansion without relying on external financing. A strong and growing FCF suggests that a company has the flexibility to pursue strategic opportunities and weather economic downturns, making it a key indicator for sustainable growth and shareholder value.

What is a Good Free Cash Flow (FCF)?

What constitutes a "good" Free Cash Flow can vary significantly across industries, but generally, a positive and consistently growing FCF is desirable. Companies with consistently high FCF often operate in mature industries or have strong competitive advantages, allowing them to generate significant cash without heavy reinvestment, like established consumer goods companies (e.g., Coca-Cola) or software giants (e.g., Microsoft). In contrast, high-growth industries like technology startups or capital-intensive sectors such as manufacturing or infrastructure may show lower or even negative FCF in their early stages as they invest heavily in research and development or new equipment to scale operations (e.g., Tesla in its growth phase, or a new semiconductor manufacturer). For these companies, investors look for improving FCF trends over time. Negative FCF for an extended period can be a red flag, indicating that a company might be struggling to generate sufficient cash from its operations to cover its investments, potentially leading to increased debt or dilution of shares. Therefore, it's crucial to compare a company's FCF to its historical performance and its industry peers.