Accounting profit and real cash are not the same thing. A company can report rising earnings while burning through cash, or report modest earnings while generating plenty of it. Free cash flow (FCF) cuts through this by measuring the cash a business actually has left over.
The formula
Free cash flow = operating cash flow − capital expenditures
- Operating cash flow is the cash generated by the core business, found at the top of the cash flow statement.
- Capital expenditures (capex) are what the company spends on buildings, equipment and other long-term assets to keep running and growing.
Example: if a company generates $5 billion of operating cash flow and spends $1.5 billion on capex, its free cash flow is $3.5 billion.
Why it matters
Free cash flow is the money available to reward shareholders and strengthen the business. A company can use it to pay dividends, buy back shares, pay down debt, make acquisitions or build up cash. Companies with strong, growing free cash flow have more options and are less dependent on borrowing. It is also the input to a discounted cash flow (DCF) valuation; you can try one with our DCF calculator.
Useful ratios
- FCF yield = free cash flow ÷ market cap. It works like an earnings yield based on cash: a 5% FCF yield means the company generates $5 of free cash a year for every $100 of stock value.
- FCF margin = free cash flow ÷ revenue. It shows how much of each sales dollar becomes free cash.
- FCF per share: useful for comparing against the share price or earnings per share.
Red flags and caveats
- Profits but no cash: if net income keeps rising but free cash flow doesn't, check whether customers are slow to pay or inventory is piling up.
- Stock-based compensation: paying employees in shares isn't a cash cost, so it boosts operating cash flow. It still costs shareholders through dilution.
- Lumpy capex: a company in a heavy investment phase may show weak FCF for a few years for good reasons. Look at the trend over several years.
- Negative FCF is normal for many young, fast-growing companies, but they will eventually need to raise money if it continues.
Where to find it
Every StockEngine stock page shows five years of cash flow statements under Financials, including operating cash flow, capex and free cash flow. For a wider tour of the three statements, read how to read financial statements.
This article is educational and not investment advice.
StockEngine articles are for education only and are not investment advice. Some links may be affiliate links.