Free Cash Flow
FREE CASH FLOW FORMULA
There are a few ways to calculate free cash flow. The most commonly used formula is:
Free cash flow = Operating Cash Flow (OCF) – Capital Expenditures
FREE CASH FLOW BENEFITS
-
Growth and opportunities.
Free cash flow allows businesses to pursue growth opportunities such as investments, purchases, or the development of new products and services.
-
Possibility for expansion.
It is a leverage if a company is looking for investments to expand. Without being able to demonstrate financial health via free cash flow, investors won’t be keen to invest in that company.
FREE CASH FLOW LIMITATIONS
-
No forecast is a crystal ball.
Financial forecasts are simply well-educated guesses or assumptions. While they can be relied upon, there are always factors out of everyone’s control that could impede a company’s free cash flow.
-
Free cash flow is best for short-term only.
Free cash flow is great for short-term projections and investments, but over the long run, there are too many variables. Recessions, advancements in technology, or bad reviews on a brand new product, can steer a company in a direction.
-
It only works with complete transparency.
There can’t be anything left off the books or calculated incorrectly. Otherwise the final free cash flow calculations will be incorrect and that can land a lot of people in hot water.
FREE CASH FLOW VS. NET INCOME