Free Cash Flows

Prepared by: John Lloyd M. De Guzman

01 What is Free
Cash Flow
(FCF)?
What Is Free Cash Flow (FCF)?
• A company's free cash flow (FCF) is the money it has left over after paying for its
operating expenses and capital asset maintenance. Free cash flow, then, is the money
that remains after a business pays its operating expenses (OpEx) and capital
expenditures (CapEx).

• FCF is the money that is left over after paying for expenses like payroll, rent, and taxes
and can be used in anyway that the company sees fit. The management of a company's
cash flow will be aided by knowing how to compute and analyze free cash flow.
Investors will be able to make wiser investment choices with the help of FCF
computation, which will also give them insight into a company's financials.
What Is Free Cash Flow (FCF)?
• Free cash flow is a crucial metric since it reveals how well a business generates cash.
Using free cash flow, investors can determine whether a company has enough cash on
hand to pay dividends or repurchase shares. Additionally, a company is better positioned
to pay down debt and pursue possibilities that can improve its business the more free
cash flow it generates, making it a desirable investment for investors.
 How to
02 Calculate Free
Cash Flow
(FCF)
How to Calculate Free Cash Flow
(FCF)
• Due to the fact that no two businesses have the identical financial accounts, there are
three alternative ways to calculate free cash flow. Given the data a corporation gives, the
result should be the same regardless of the methodology employed. Operating cash flow,
sales revenue, and net operating profits are the three inputs used to compute free cash
flow.
How to Calculate Free Cash Flow
(FCF)
1. Using Operating Cash Flow
• The most popular way is to use operating cash flow to determine free cash flow since it
is the simplest and makes use of two variables that can be easily located in financial
statements: operating cash flow and capital expenditures. Locate the line item cash flow
from operations (also known as "operating cash" or "net cash from operating activities")
from the cash flow statement and deduct capital expenditure, which may be found on the
balance sheet, to calculate FCF.

• The formula is:

Free Cash Flow = Operating Cash Flow – Capital Expenditures
How to Calculate Free Cash Flow
(FCF)
2. Using Sales Revenue
• Using sales revenue focuses on the income a firm derives from its operations after
deducting the expenses related to doing so. The income statement and balance sheet are
used as the information source in this method. On the income statement, find sales or
revenue. Subtract taxes from that amount, then add all running expenses (often known as
"operating expenses"), which might include things like cost of goods sold (COGS) and
selling, general, and administrative charges (SG&A).
• The net investment in operating capital, which is derived from the balance sheet, is then
subtracted from the required investments in operating capital.
How to Calculate Free Cash Flow
(FCF)
Formula using Sales Revenue
Free Cash Flow = Sales Revenue – (Operating Costs + Taxes) – Required
Investments in Operating Capital
Where:
Required Investments in Operating Capital = Year One Total Net Operating Capital – Year
Two Total Net Operating Capital
And where:
Total Net Operating Capital = Net Operating Working Capital + Net Plant, Property, and
Equipment (Operating Long-Term Assets)
And Where:
Net Operating Working Capital = Operating Current Assets – Operating Current Liabilities
How to Calculate Free Cash Flow
(FCF)
Formula using Sales Revenue
And Where:
Operating Current Assets = Cash + Account Receivable + Inventory
Operating Current Liabilities = Accounts Payable + Accruals
How to Calculate Free Cash Flow
(FCF)
3. Using Net Operating Profits
• To calculate free cash flow using net operating profits after taxes (NOPATs) is similar to
the calculation of using sales revenue, but where operating income is used.
The Formulas is:
Free Cash Flow = Net Operating Profit After Taxes – Net Investment in Operating capital
Where:
Net Operating Profit After Taxes = Operating Income x (1 – Tax Rate)
And where:
Operating Income = Gross Profits – Operating Expenses
03 Interpreting
Free Cash Flow
(FCF)
Interpreting Free Cash Flow (FCF)
• Increasing free cash flows usually come before rising earnings. Companies with soaring FCF
today could reward investors tomorrow if they increase sales, become more efficient, cut costs,
repurchase shares, pay dividends, or pay off debt. For this reason, FCF is highly regarded in
the investment community as a yardstick of worth. The likelihood that earnings and share
value will increase soon is high when a company's share price is low and its free cash flow is
increasing.
• On the other hand, declining FCF may indicate that businesses are unable to maintain earnings
growth. Companies may be forced to increase debt levels or lose their ability to maintain
liquidity if their FCF is insufficient to support earnings growth. Having said that, a declining
FCF is not always a bad thing, especially if rising capital expenditures are being used to invest
in the expansion of the business, which could boost future sales and profits.
Interpreting Free Cash Flow (FCF)
• Increasing free cash flows usually come before rising earnings. Companies with soaring FCF
today could reward investors tomorrow if they increase sales, become more efficient, cut costs,
repurchase shares, pay dividends, or pay off debt. For this reason, FCF is highly regarded in
the investment community as a yardstick of worth. The likelihood that earnings and share
value will increase soon is high when a company's share price is low and its free cash flow is
increasing.
• On the other hand, declining FCF may indicate that businesses are unable to maintain earnings
growth. Companies may be forced to increase debt levels or lose their ability to maintain
liquidity if their FCF is insufficient to support earnings growth. Having said that, a declining
FCF is not always a bad thing, especially if rising capital expenditures are being used to invest
in the expansion of the business, which could boost future sales and profits.