Cash flow refers to a stream of revenue or expense that alters a cash account over a specified time frame. Free cash flow (FCF) is a measure of a business’s financial performance. It is calculated as the difference between cash flow and capital expenditures.
Cash inflows result from any of the following three activities: financing, investments or operations. Cash outflows, on the other hand, result from expenses or investments. A statement of cash flows is an accounting statement that shows the amount of income generated and used by the business in a given time period. It is calculated by summing non-cash charges including depreciation, with net income after taxes. The data used in the statement of cash flows are obtained from the business’ balance sheet.
FCF shows how much cash a company generates after accounting for capital expenditures, such as buildings and equipment. It is a representation of cash that a business is able to generate after laying out the money needed for expansion of its asset base. The importance of FCF is that it allows the business to take advantage of opportunities that increase shareholder value. It is impractical to create new products, pay dividends, make acquisitions or reduce cost when there is no cash.
FCF = Operating cash flow – capital expenditures.The data used for calculating a company’s free cash flow is usually obtained from its cash flow statement. For instance, if company ABC’s cash flow statement recorded $20 million from operations and $10 million of capital expenditures for the year: Company ABC’s free cash flow (FCF) = $20 million - $10 million = $10 million.
Source : Investopedia