Free cash flow (FCF) is regarded as a very important number in valuation of a company and also evaluating company performance.
It is the cash available to the company after meeting its operating expenses and capital expenditure.
FCF = Operating cash + Changes in working capital – Capital expenditure.
To get a better grasp of operating cash lets go through a typical Profit and loss statement
To arrive at operating cash we start with operating income, add depreciation to it because although its a operating expense but a non cash one, which mean no cashflow has occured actually out of company. We less taxes from this number to arrive at operating cash
Operating cash = Operating income + Depreciation – Taxes
Changes in working capital : Working capital include current assets like Accounts receivables and Inventory and Current liabilities like Accounts payable. An increase in current assets is a negative number because more amount is employed in Working capital and increase in current liability is a positive number because by that amount the creditors are funding your business.
Capital expenditure : It is the amount the company has invested in purchase of fixed assets for long term use.
We will try to understand the concept by assuming numbers in P&L and Working capital
Therefore the FCF
The FCF can be further elaborated by arriving at operating cash in different ways like
Operating cash = EBIT + Depreciation – Taxes or EBITDA – Taxes or PBT + Interest + Depreciation – Taxes or PAT + Interest +Depreciation
Hope you enjoyed the post, thanks !