How to calculate free cash flow
Free cash flow (FCF) is a crucial financial metric used by investors and analysts to evaluate a company’s financial health. It represents the amount of money a company has available after it has paid operating expenses, taxes, and other obligations. FCF can be used to expand the business, repurchase shares, pay down debt, or distribute dividends. In this article, we will take you through the step-by-step process of calculating free cash flow.
Step 1: Gather financial data
To begin calculating free cash flow, you will need access to a company’s financial statements – specifically, the income statement and balance sheet. These can usually be found in the annual or quarterly reports on the company’s investor relations website.
Step 2: Find operating cash flow
Operating cash flow (OCF), also known as cash flow from operations, is the starting point for calculating free cash flow. OCF can be found in the cash flow statement and it represents the cash generated by a company’s core operating activities.
Step 3: Determine capital expenditures
The next step is to identify the company’s capital expenditures (CAPEX), which are investments made in fixed assets like machinery, equipment, or property. CAPEX is usually listed under “investing activities” on the cash flow statement.
Step 4: Calculate free cash flow
Now that you have both operating cash flow and capital expenditures, you can calculate free cash flow using this formula:
Free Cash Flow = Operating Cash Flow – Capital Expenditures
This simple calculation provides you with the free cash flow generated by a company during a specific period.
To illustrate this process, let’s consider the following hypothetical figures:
Operating Cash Flow: $10 million
Capital Expenditures: $3 million
Using our formula:
Free Cash Flow = $10 million – $3 million
Free Cash Flow = $7 million
In this example, the company has generated $7 million in free cash flow.
Calculating free cash flow is a valuable exercise when assessing a company’s financial performance. A positive FCF indicates that a company has enough money to fund its operations and growth, while a negative FCF may imply the need for additional financing. By understanding how to calculate free cash flow, investors can gain insights into a company’s overall financial well-being and make informed decisions.