Free Cash Flow (FCF)

Free Cash Flow (FCF) is the cash generated by a business after paying for operating expenses and capital expenditures. It's the money truly available to shareholders and debt holders. The formula is Operating Cash Flow minus Capital Expenditures, or alternatively Net Income plus Depreciation minus Changes in Working Capital minus CapEx.

FCF matters because cash can't be manipulated like earnings, it shows actual money available, funds dividends and buybacks, enables debt paydown, and allows for acquisitions. For example, if a company has $100 million in operating cash flow and $30 million in capital expenditures, its free cash flow would be $70 million.

Unlike net income, which is an accounting profit that includes non-cash items and can be manipulated, free cash flow represents actual cash that's harder to fake. Net income appears on the income statement while FCF is derived from the cash flow statement.

Companies typically use FCF in several ways: paying dividends to return cash to shareholders, buying back stock, repaying debt to reduce leverage, making acquisitions of other companies, and reinvesting to fund growth.

FCF Yield is calculated as Free Cash Flow divided by Market Cap, where a higher yield generally indicates potentially better value.

Regarding negative FCF, growth companies often have negative FCF because they're investing heavily, while mature companies should have positive FCF. Persistent negative FCF is a warning sign, though it's important to check if negative FCF is for a good reason such as growth investments.

For effective FCF analysis, look at the trailing 3-5 year average to smooth volatility, compare FCF to net income, check the FCF trend direction, consider industry CapEx requirements, and calculate FCF margin (FCF divided by Revenue).