What is Free Cash Flow?

Free cash flow refers to the cash that a firm has post its cash outflow transactions which it uses for carrying its business activities and sustaining its long-term assets. 

Free cash flow is not the same as earnings or net income. It ascertains profits excluding the non-cash or non-liquid expenses recorded in the income statement, and includes expenses related to equipment and assets, and variations in working capital. 

Free cash flow also does not include interest payments. 

For ascertaining the estimated performance of a company regarding various capital structures, investment bankers and financial analysts use different types of free cash flow - such as free cash flow for the firm and free cash flow to equity. These free cash flow are balanced for interest payments and loans.

How Does Free Cash Flow Work?

Free cash flow is cash provided by operating activities minus capital expenditures. The idea is that companies must continue to invest in fixed assets to remain competitive. 

Free cash flow provides information regarding how much cash generated from daily operations is left over after investing in fixed assets. 

The free cash flow formula is as follows:

Free cash flow = Cash provided by operating activities − Capital expenditures

The cash provided by operating activities comes from the bottom of the operating activities section of the statement of cash flows. 

The capital expenditures amount comes from information within the investing activities section of the statement of cash flows.

Related Topics

• Statement of Cash Flow
• Operating Cash Flow Ratio
• Capital Expenditure Ratio
• Free Cash Flow
• Cash Conversion Cycle