Free Cash Flow

FREE CASH FLOW

An important factor in Shareholder Value Added analysis is the free cash flow (FCF) generating capability of a company.

This is the cash flow available after allowing for capital maintenance and interest payments.  FCF is calculated as:

Operating profit

Plus depreciation

Less cash tax paid

= Cash profits

Less investment in non-current assets and investment in working capital

= Free Cash Flow

FCF is useful in providing an indication of the level of a company’s cash flow generation.  

It also measures the amount of cash potentially available to cover the financing costs of the business after all necessary investment has been made.  Can the company safely consider raising more finance or making a major capital investment?

Companies often provide figures for their FCF, but there is no standard definition of the term so be cautious in using them.

If all interest payments are deducted, the resultant “levered free cash flow” indicates the amount of cash potentially available for dividends and future growth.

It is useful to compare the growth in free cash flow with that of earnings.  If the trends are significantly different, is it possible to find the reason?