Calculating Free Cash Flow (FCF)

If cash is the lifeblood of a business, then Free Cash Flow (FCF) is the healthy pulse that indicates its real financial strength. Just like a mango seller needs to know how much profit remains after paying workers and maintaining the orchard, companies need to know how much cash they have left after taking care of their operational and investment needs. That leftover cash is called Free Cash Flow.

What is Free Cash Flow?

Free Cash Flow is the money a company generates after covering all its operating expenses and capital expenditures (CapEx). It represents the actual cash available to the company for expansion, paying dividends, reducing debt, or other purposes. Investors focus heavily on FCF because profits shown in financial statements can sometimes be misleading, but real cash cannot be faked.

Formula to Calculate Free Cash Flow:

FCF = Operating Cash Flow - Capital Expenditures

Where:

• Operating Cash Flow (OCF): Cash generated from core business operations (found in the cash flow statement).
  

• Capital Expenditures (CapEx): Money spent on maintaining or acquiring fixed assets like plants, machinery, equipment.
  

Step-by-Step Breakdown:

1. Start with Net Cash from Operating Activities (from the Cash Flow Statement).
   

2. Subtract Capital Expenditures — funds used to purchase or maintain fixed assets.
   

3. Arrive at Free Cash Flow — the cash truly free for shareholders and business growth.
   

Example:

Imagine a company, say Britannia Industries. Suppose its operating cash flow for the year is ₹2,000 crore and its capital expenditures amount to ₹500 crore.

Then:

FCF = 2,000 - 500

FCF = 1,500 crore

This ₹1,500 crore is the real free cash flow available to the company for reinvestment, debt repayment, or rewarding shareholders.

Why is Free Cash Flow Important?

• Real Financial Health Indicator: Unlike profits, FCF shows how much actual cash the business can produce.
  

• Flexibility for the Future: Companies with strong FCF can reinvest, innovate, survive downturns, or return money to shareholders without taking on debt.
  

• Valuation Foundation: FCF forms the base for calculating a company's intrinsic value using methods like Discounted Cash Flow (DCF) analysis.
  

Tip: When analysing a company, look for consistent or growing free cash flow over multiple years. Be cautious of companies where profits are rising but free cash flow is shrinking.

Understanding and calculating Free Cash Flow is essential to see through the glossy surface of reported earnings. It is the fuel that powers genuine business growth and shareholder returns. In the next chapter, we will learn about Comparable Company Analysis (CCA) — a popular relative valuation method that benchmarks businesses against their peers.