Free Cash Flow Explained: Why Cash Beats Profit

Three cash flow statements in one

The cash flow statement tracks actual cash in three buckets: operating (the business itself), investing (equipment, acquisitions) and financing (borrowing, repaying, dividends, buybacks).

The formula

Free cash flow = cash flow from operations − capital expenditures. Capital expenditures, or capex, is money spent on equipment, buildings and technology to keep or grow the business.

A made-up example

A company reports 90 in net income, but cash from operations is 140 because of non-cash charges like depreciation. It spends 60 on equipment. FCF is 140 − 60 = 80. If shares outstanding are 100, that is 0.80 of FCF per share.

Why investors care

• FCF pays dividends and buybacks, reduces debt and funds new projects.
• Steady, growing FCF often signals a healthy business.
• A P/E ratio can be distorted by accounting; FCF is harder to dress up.

FCF yield

Divide FCF per share by the share price (or total FCF by market cap) to get FCF yield. Using the example, an 80 FCF on a 1,600 market cap is a 5% yield. Compare across similar companies.

Cautions

• Fast-growing companies may spend heavily and show low or negative FCF on purpose. Judge by what the spending buys.
• One strong year can come from delaying capex. Look at several years.

Quick answers

Is negative free cash flow always bad?
Not always, especially in young, growing firms. It becomes a concern if the company relies on outside money for years without a path to positive cash flow.