Investiční slovník
Free Cash Flow: What It Is and Why Investors Track It
Key takeaways
- Free cash flow is the cash left to a company after paying all operating costs and capital expenditures (capex).
- Unlike accounting profit, FCF cannot easily be manipulated — the cash is either in the account or it is not.
- A company can use FCF for dividends, share buybacks, debt repayment, or acquisitions.
- Negative FCF is not necessarily a disaster — a young growth company invests in capacity, but persistently negative FCF is a warning sign.
- FCF yield (FCF / market capitalization) is a popular metric among value investors for comparing companies.
Free cash flow is the cash a company actually generated from operating activities after subtracting capital expenditures for maintaining and developing its assets — in other words, what genuinely remains in the company's account. It is one of the most straightforward indicators of a company's financial strength.
How FCF Is Calculated
The basic formula is simple: FCF = Operating cash flow − Capital expenditures (capex). Operating cash flow can be found in the cash flow statement, and capital expenditures in the same statement or in the notes to the financial statements.
Why not use accounting profit? Accounting profit can be influenced by the choice of depreciation methods, capitalization of costs, or other legitimate accounting techniques. Cash is more straightforward — it is either in the account or it is not. That is why Warren Buffett and other value-oriented investors prefer FCF to net income.
What a Company Does with FCF
Free cash flow can be directed in five ways. First, dividends — direct payment of cash to shareholders. Second, share buybacks — the company buys its own shares and thereby increases the proportional ownership of existing shareholders. Third, debt repayment — reduces financial risk. Fourth, acquisitions — purchasing another company. Fifth, growth investments — capex beyond maintenance spending.
Negative FCF — When to Worry and When Not To
Negative FCF is not automatically bad news. A young tech company or an e-commerce firm in expansion mode invests in capacity more than it currently earns — and that is part of the plan. The problem arises when negative FCF persists for years without visible reason for optimism and the company has to keep borrowing just for operations.
Where to Find FCF in Practice
FCF is not always reported directly — you have to calculate it. In the annual report, look for the lines "Cash from operations" and "Capital expenditures" in the cash flow statement. Many financial websites (Morningstar, Macrotrends) pre-calculate FCF. The basics of company analysis are practiced in the company reviews section. How to compare companies within an ETF is described in active vs. passive investing.
FAQ
What is free cash flow in simple terms?
Free cash flow is the cash that genuinely remains with a company after paying all operating costs and capital investments. It is more straightforward than accounting profit because cash cannot be manipulated by accounting techniques as easily.
Why is FCF more important than net income?
Net income can be affected by the choice of depreciation methods and other accounting techniques. FCF reflects actual cash flows. Value-oriented investors therefore prefer it — a company either generates cash or it does not.
What does negative FCF mean?
Negative FCF is not necessarily a problem — young growth companies invest in capacity. The problem is FCF that remains negative for years without an investment rationale, when the company has to keep borrowing just for operations. Context is key.
What is FCF yield and how should I read it?
FCF yield = FCF divided by market capitalization. It tells you how much free cash a company generates per unit of price paid. The higher it is, the cheaper the shares are relative to their cash-generating ability. Always compare within the same sector.