Free Cash Flow Formula

Free Cash Flow Formula (Table of Contents)

• Free Cash Flow Formula
• Free Cash Flow Formula Calculator
• Free Cash Flow Formula in Excel(With Excel Template)

Free Cash Flow Formula

Free Cash Flow can be defined as the cash flow available to the firm net of any funds invested in capital expenditure and working capital for the year.

Here’s the Free Cash Flow Formula –

Examples of Free Cash Flow Formula

Let’s take an example to find out the Free Cash Flow for a company: –

Example #1

Company A which has operating cash flow of $50000 and capital expenditure for the year is $30000. The net working capital for the year is $5000.

Hence,

Free cash flow available to the firm for the calendar year is: –

• Free Cash Flow = Operating Cash Flow – Capital Expenditure – Net Working Capital
• Free Cash Flow = $50000 – $30000 – $5000
• Free Cash Flow = $15000

Hence the Free Cash Flow for the year is $15000

Example #2

Taking an example of Schlumberger which has operating cash flow of $300 million. The capital expenditure for the year is $50 million and the net working capital is $125 million for the year.

Hence,

Free cash flow available to the firm for the calendar year is: –

• Free Cash Flow = Operating Cash Flow – Capital Expenditure – Net Working Capital
• Free Cash Flow = $300 million – $50 million – $125 million
• Free Cash Flow = $125 million

Hence the Free Cash Flow For the year is $125 Million

Example #3

Taking an example of Exxon Mobil which has operating cash flow of $550 million. The capital expenditure for the year is $100 million and the net working capital is $175 million for the year.

Hence,

Free cash flow available to the firm for the calendar year is: –

• Free Cash Flow = Operating Cash Flow – Capital Expenditure – Net Working Capital
• Free Cash Flow = $550 million – $100 million – $175 million
• Free Cash Flow = $275 million

Hence the Free Cash Flow for the year is $275 Million

Explanation of Free Cash Flow Formula

Free Cash Flow can be defined as the cash flow available to the firm net of any funds invested in capital expenditure and working capital for the year.

The formula for the free cash flow is

FCF = Operating Cash Flow – Capital Expenditure – Net Working Capital

• Operating Cash Flow

It can be determined in two ways: –

Operating Cash Flow = EBIT (1-t) + Depreciation and Non-cash expenses

Or

Operating Cash Flow = Net Income + Interest (1-t) + Depreciation and non-cash expenses

Where EBIT is Earnings before Interest and Taxes.

• Net Working Capital

Net working capital = Working Capital_{Current year} – Working Capital_{previous year}

Working Capital in any year = Accounts Receivable + Inventory – Accounts Payable

• Capital Expenditure

The capital expenditure can be determined either from the Balance Sheet or Cash Flow Statement or both.

Capex for a year = PPE_{current year} – PPE_{previous year} + Depreciation & Amortization

Where PPE stands for Property, Plant, and Equipment

Significance and Use of Free Cash Flow Formula

Free Cash Flow is majorly used by investors to estimate the health of any company. It can provide deep insights into the financial operations of the firm and whether sufficient cash flow is present to fund future expansion. Free cash flow also indicates to the investors that there is ample cash flow available with the company to reduce its debt or fund future expansion or give dividends to investors or buyback stock etc.

If free cash flow is negative for multiple years, it indicates that the company is not able to utilize its capital expenditure properly. Alternative it may also mean that working capital is not managed properly which is impacting sales and hence the bottom line. It can also provide insights into trends such as whether the accounts receivable and accounts payable are being managed efficiently.

Free cash flow is also an important technique which is used to value an entire company. The Discounted Cash Flow method uses Free Cash Flow for a set number of years either 5, 10 or so on and then discounts those cash flows using the Weighted Average Cost of Capital to reach a certain valuation for the company. There are two types of Free Cash Flows. One is the Free Cash Flow to the Firm and the other is Free Cash Flow to the Equity. As the name indicates, the Free Cash Flow to the Firm denotes the cash flow available to the entire firm which includes shareholders as well as debtholders. Free Cash Flow to the Equity denotes the cash flow available to shareholders only after subtracting debt payments to the debtholders.

Free Cash Flow is also used by investors as a proxy for stock prices. The fundamental principle underlying that is whether the company is able to generate sufficient cash for its operations. Hence if any particular company has high or improving cash flows over the years but its stock is sufficiently undervalued or if there is a disparity, then the company is worth investing in as the market has not taken into account the company’s good performance.

Free Cash Flow Formula Calculator

You can use the following Free Cash Flow Formula Calculator

Free Cash Flow Formula in Excel (With excel template)

Here we will do the example of the Free Cash Flow Formula in Excel. It is very easy and simple. You need to provide the three inputs i.e Operating Cash Flow, Capital Expenditure and Net Working Capital

You can easily calculate the Free Cash Flow using Formula in the template provided.

Conclusion

Free Cash Flow indicates whether the company is generating sufficient cash to fund its operations. It also signals that the company has the cash to reduce its debt or fund future expansion or pay dividends to its investors. Free Cash Flow is calculated by taking net income and adding back any non-cash expenses and subtracting capital expenditure and any changes in working capital in that year. Free Cash Flow is used in the various number of ways primarily by investors to gain insights on the health of a company and also to value the company as a whole. Higher cash flows not reflected in stock prices of a company reflects that the market has not taken into account the good performance of a company and the company is a good bet to invest in.

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