Free Cash Flow (FCF) Defined
Free Cash Flow or FCF is another measure of a company’s financial performance. Operating cash flow minus capital expenditures results in FCF. More specifically, it is EBITDA – change in net working capital – capital expenditures. Cash flow is paramount for any company, regardless of their growth trajectory. However, for growing companies or startups, it is the lifeblood that keeps the company alive.
Furthermore, FCF allows companies to pursue new projects that increase shareholder value. A growing company with large FCF focuses on expanding production of popular products, developing new products, or acquisitions. These investments grow companies over time and yield larger returns.
Why Use Free Cash Flow?
Equity analysts focus on earnings and revenues in evaluating companies each quarter. However, earnings are easily changed or adjusted due to accounting practices. Conversely, cash amounts cannot be argued or manipulated.
Additionally, why does this matter? Some believe FCF is the best indicator of future company performance. This is not to say that companies with negative FCF are poor. Companies that invest heavily in new projects are often strapped for cash. However if these projects lead to long term value, the company becomes bigger and more profitable. For this reason, some investors only look to FCF before making decisions.
Finding Free Cash Flow
Simply enough, a statement called the “cash flow statement” lists precisely where the cash moves. This statement compliments the income statement and the balance sheet. Consider is more of a legend in decoding the aforementioned statements. This is where investors go if they want to dig deeper into a specific item of the income statement or balance sheet.
In conclusion, free cash flow is integral to all companies, but differs in analysis. Variable cash flow are common in oil and gas companies who make huge investments every few years. Start up companies may have little to negative FCF, while capital light companies FCF usually matches their income. Rather than make blanket statements, FCF tells different stories with each company.