What is Free Cash Flow?
Free cash flow (FCF) is a profitability measure that indicates how much cash a company has left over at the end of a reporting period after taking care of capital expenditures and working capital needs.
How to Calculate Free Cash Flow
To calculate a company’s free cash flow, subtract all capital expenditures and cash dividends paid from net operating cash flow. All three line items are listed on the cash flow statement.
How To Interpret Free Cash Flow
Free cash flow is what Warren Buffett calls “owner earnings”, since it is the amount of money left over after subtracting any capital expenditures and cash dividends paid.
Positive and growing free cash flow over the past 5 to 10 years confirms that a company is profitable and is a good indicator that the company benefits from one or several types of durable competitive advantage.
Having positive free cash flow is advantageous for three reasons:
- There is plenty of money to cover the company’s operational needs.
- The left-over free cash flow can be strategically used for future growth
- Shareholders benefit if it is used to buy back shares or pay out dividends.