Free cash flow (FCF) cheat sheet

• Free cash flow (FCF) is cash flow generated to both creditors and shareholders after all essential investments into the business (Net working capital and Capital expenditures).
• Positive free cash flow (FCF) on a sustainable basis is essential for smooth servicing of financial debt, company’s viability on the long-term basis (going-concern assumption) and is corresponding with positive value creation for both creditors
and shareholders.
• Negative free cash flow (FCF) equals cash burn.
• Company with negative free cash flow (FCF) on an ongoing long-term basis will very likely go bankrupt unless shareholders are willing to continuously inject new equity capital.
• Free cash flow (FCF) typically means Free cash flow to firm (FCFF).

1) Free cash flow (FCF) ≈ EBITDA – Capital expenditures (CAPEX); EBITDA is a first proxy for operating cash flow
2) Free cash flow (FCF) = EBITDA – Cash tax – Changes in net working capital (∆NWC) – Capital expenditures (CAPEX); For DCF model financial plan purposes tax has to be calculated from operating profit (EBIT)
3) Free cash flow (FCF) = Operating cash flow – Capital expenditures (CAPEX)

4) Free operating cash flow (FOCF) = Free cash flow (FCF) – Interest costs

5) Net free cash flow (Net FCF) = Free cash flow (FCF) – Interest costs – Dividends – Share buybacks + New equity injected ≈ – ∆ Net debt → Total cash flow before old debt repayments and new debt raised

• M&A, i.e. acquisitions and asset disposals/divestures, should be generally added to the free cash flow (FCF) calculation.

• Analysts and investors are obsessed with EBITDA nowadays. However EBITDA is typically rather poor proxy for underlying free cash flow (FCF) generation. Therefore it is very reasonable to analyze cash conversion, i.e. how many dollars of
free cash flow (FCF) company generates from every 100 dollars of EBITDA:
1) Cash conversion 1 = Unlevered cash conversion (%) = Free cash flow (FCF) / EBITDA
2) Cash conversion 2 = Levered cash conversion (%) = Free operating cash flow (FOCF) / EBITDA

• Discounting projected FCF by weighted average cost of capital (WACC) yields Enterprise value (EV) valuation estimate. To calculate equity value valuation estimate you have to deduct net debt. To calculate net debt you have to sum all debt
instruments, such as bank loans, bonds and leasing, at subtract cash and cash equivalents.

• Free cash flow to equity (FCFE) = Free cash flow (FCF) – Interest costs – Old debt repayments + New debt raised
• Discounting projected FCFE by cost of equity yields directly equity value valuation estimate.

Michal Stupavský, CFA