What is Free Cash Flow?

FCF, or free cash flow, is net income earned from a business venture along with any depreciation or amortization that is relevant to the company. The amount of free cash flow does allow for any changes in the amount of working capital on hand as well as any shifts in capital expenditures for the period under consideration. It is free cash flow that is used by the company to honor its obligations to stockholders and others who hold debt or equity in the corporation. While not free cash in the sense that the funds can be used for anything, the cash flow is free in that it is not required to maintain the basic production functions of the company.

Calculating this cash minus expenditures involves knowing such important line items as current depreciation on property, the value of intangible assets after allowing for amortization, any interest or investment income received, returns from the sale of stocks, and any monies collected as a result of selling property. Taking all these factors into consideration makes it possible to arrive at what is known as the headline operating profit. This figure serves as the starting point for determining the amount of FCF that is currently on hand and can be used to issue payments to stockholders and others who hold debt or equity instruments issued by the company.

Under the best circumstances, any company should have a healthy free cash flow at the end of each financial period. Not only is the flow of profits necessary to allow the company to honor all its financial obligations, it also provides the foundation for future expansion. That expansion may come in the form of improving existing facilities, developing and marketing new products, or creating new facilities in new locations. The presence of the free cash flow means the company is in a good position to grow and become even more profitable.

Stockholders are always happy when a company posts a positive free cash flow. The presence of a cash flow that is free and in the black rather than in the red means there will be no problems in receiving dividend payments and may possibly be an indicator that the company may find it feasible to issue additional shares in the near future. It also means the company is managing expenses in an efficient manner, which helps to maximize the chances for the stock holdings to continue to earn dividends in the future.