======Free Cash Flow (FCF)======
Free Cash Flow (FCF) is the cash a company generates after accounting for the cash outflows required to support its operations and maintain its capital assets. Think of it as the company’s //real// profit. It’s the pot of gold left over after all the essential bills are paid—the money that is truly "free" to be used for the benefit of its shareholders. Unlike accounting metrics like [[Net Income]], which can be influenced by non-cash expenses and accounting rules, FCF represents the actual cash a business has on hand. For [[Value Investing|value investors]], FCF is a superstar metric because it cuts through the noise. A company that consistently gushes cash is like a healthy, fruit-bearing tree; it has the resources to pay down [[Debt]], reward shareholders with [[Dividends]] or [[Share Buybacks|share buybacks]], and reinvest for future growth. A company can report a profit on paper but go bankrupt if it doesn't generate enough cash to pay its bills, making FCF a crucial reality check for any serious investor.
===== Why FCF Matters More Than Net Income =====
It’s easy to get fixated on a company's Net Income, often called the "bottom line." However, Net Income is an accounting figure, not a cash figure. It includes non-cash charges like [[Depreciation]] and [[Amortization]] and can be subject to management’s accounting choices, which can sometimes paint a rosier picture than reality.
FCF, on the other hand, is much harder to fake. It tracks the actual cash moving in and out of the company’s bank accounts. A company needs cash—not accounting profits—to run its day-to-day operations, pay its employees, and invest in its future.
An easy analogy:
  * **Net Income** is like your advertised annual salary. It looks good on paper but doesn't account for taxes, insurance, and other deductions.
  * **Free Cash Flow** is like the actual money you have left in your bank account at the end of the month after paying your rent, groceries, and all other necessary expenses. It’s the money you can actually use to save, invest, or go on vacation.
A company with growing Net Income but negative FCF might be in serious trouble, as it could be running out of the very fuel—cash—it needs to survive.
===== Calculating Free Cash Flow =====
While there are several variations, the most common and straightforward way to calculate FCF starts with the [[Cash Flow Statement]].
==== The Classic Formula ====
The simplest and most reliable formula is:
**FCF = [[Operating Cash Flow]] - [[Capital Expenditures (CapEx)]]**
Let's break that down:
  * **Operating Cash Flow (OCF):** This is the cash generated from a company's normal business activities. You can find this number directly on the Cash Flow Statement. It represents the cash inflow from the core business.
  * **Capital Expenditures (CapEx):** This is the money the company spends on acquiring or maintaining its physical assets, such as property, plants, and equipment. This is also found on the Cash Flow Statement, often listed as "purchase of property and equipment." It represents the cash outflow needed to keep the business running and growing.
By subtracting the money needed to maintain the business (CapEx) from the money the business brings in (OCF), you are left with the "free" cash.
==== A Quick Back-of-the-Envelope Calculation ====
If you want to understand the mechanics a bit more, another formula starts with Net Income. It's more complex but shows how accounting profit is reconciled with cash.
**FCF ≈ Net Income + Depreciation & Amortization - Change in [[Working Capital]] - Capital Expenditures**
This formula adds back non-cash expenses (Depreciation & Amortization) and adjusts for changes in short-term assets and liabilities (Working Capital) to get a closer approximation of cash flow.
===== What to Look for as a Value Investor =====
Analyzing FCF is not just about calculating a number; it's about understanding what it says about the business.
==== Positive and Growing FCF ====
A healthy company should consistently generate positive FCF. A single bad year can happen, but a pattern of negative FCF is a major red flag. Ideally, you want to see a company’s FCF growing steadily over a 5- to 10-year period. This indicates that the business is becoming more profitable and efficient over time, often protected by a strong competitive advantage or [[Moat|moat]].
==== FCF Yield ====
To determine if a company is attractively priced, investors often calculate the [[FCF Yield]].
**FCF Yield = FCF per Share / Market Price per Share**
The FCF Yield tells you how much cash the company is generating relative to its market value. A high FCF yield (e.g., above 8-10%) can suggest the stock is undervalued. It’s a powerful metric because you can compare it directly to the yield on a bond or your own required rate of return. It answers the question: "What cash return am I getting for the price I am paying today?" It's a more robust version of the [[Earnings Yield]].
==== What Does the Company Do with its FCF? ====
A company with abundant FCF has several options, and what management chooses to do is a critical indicator of its discipline and focus on shareholder value. Smart uses of FCF include:
  * **Paying down debt:** Strengthening the balance sheet and reducing risk.
  * **Paying dividends:** A direct cash return to shareholders.
  * **Buying back shares:** Increasing each remaining shareholder's ownership stake in the business.
  * **Making smart acquisitions:** Purchasing other companies to fuel growth.
  * **Reinvesting in the business:** Funding research, new products, or more efficient operations.
===== The Bottom Line =====
Free Cash Flow is one of the most honest metrics for evaluating a business. It reveals a company's true financial health and its ability to generate surplus cash for its owners. While Net Income can be debated, cash is fact. For investors focused on the long-term, fundamental strength of a business, understanding and analyzing FCF is not just a good idea—it’s an absolute necessity.