What is Free Cash Flow and How to Calculate it?

 


What is Free Cash Flow?

Free cash flow refers to how much money a business has left over after it has paid for everything it needs to continue operating—including buildings, equipment, payroll, taxes, and inventory The company is free to use these funds as it sees fit.

Businesses calculate free cash flow to guide key business decisions, such as whether to expand or invest in ways to reduce operating costs. Investors use free cash flow calculations to check for accounting fraud—these numbers aren't as easy to manipulate as earnings per share or net income. Free cash flow also gives investors an idea of how much money could possibly be distributed in the form of share buybacks or dividend payments. 

 

The free cash flow calculation tells a company how much cash it is generating after paying the costs of remaining in business. In other words, it lets business owners know how much money they have to spend at their discretion. It's a key indicator of a company's financial health and desirability to investors.

Here's how to calculate free cash flow, and why it matters to both businesses and investors.

3 ways to Calculate Free Cash Flow

1. Sales Revenue - Operating Costs & taxes = Required Investments in Operating Capital
2. Net Operating Profit After Taxes - Net Investment in operating Capital
3. Net Cash Flow from Operations - Capital Expenditures

 

By Rosemary Carlson 

Read more on thebalancesmb.com

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