Wouldn’t it be amazing if we could find a one size fits all for most of our needs? If that amazingly comfortable pair of jeans could expand or shrink with us? If that gorgeous pair of shoes would fit us forever? If we could never outgrow our car or house?
Well, in the reality of our everyday lives, this is not possible, however, in finance there is one metric that is timeless! Yes, you read it right there is one metric in finance that can be used from the very start up phase all the way to a multimillion-dollar enterprise.
Drum roll please …… it is Free Cash Flow
What is free cash flow and why is it so important? Free cash flow is important to investors because it shows how much actual cash a company has at its disposal. … Free cash flow is the money left over after a company has met its operating and capital expenditure requirements and it can be the best way to differentiate between a good investment and a bad one.
Reams have been written about the difference between cash flow and free cash flow, as an investor you need to know both of them, cash flow is used to find out how much cash goes in and out of the company, it shows the real picture, the health of the company, the actual net cash inflow of the business. Free cash flow is used to find out a company’s valuation using the Discounted Cash Flow (DCF) method.
Very simply stated 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.
Here is the formula:
FCF = Cash from operations – Capital Expenditures
Do you know how to correctly calculate it? Do you know what it means?
