Free cash flow is the cash a company generates from operations after subtracting capital expenditures — the money actually available to pay down debt, pay dividends, buy back stock, or reinvest, after keeping the business running and growing.
Why It Matters
FCF is what dividend and debt-service capacity is actually built on — a company can report strong net income or EBITDA while burning cash if working capital or capex requirements are high, and FCF is the number that catches that. DCF valuation models are built directly on projected free cash flow, not earnings.
How It Works in Practice
- 1Start with cash flow from operations (from the cash flow statement, which already adjusts net income for non-cash items and working capital changes)
- 2Subtract capital expenditures
- 3The result is unlevered free cash flow if calculated before interest, or levered free cash flow if calculated after debt service
- 4Free cash flow yield (FCF ÷ market cap or enterprise value) is used to compare cash generation across companies of different sizes
Common Pitfalls
Deferring necessary capex to boost near-term FCF is a classic way to flatter the metric temporarily at the expense of the underlying asset base
Working capital swings (a large one-time inventory build or receivables collection) can distort a single period's FCF without reflecting a change in the underlying business
Unlevered and levered FCF get used inconsistently across contexts — always confirm which one a given multiple or model is built on