Intuitively, you may think of this as the cash flow as seen on a statement of cash flows financial statement. It is close, but not exactly the same.an experienced investor, you can use this as a factor in evaluating a buy out of your competition’s business, for instance.
Also, you may think of it as the money from rents you keep free and clear of maintenance and debt repayment. That also is close. Use pre-tax values and add back in depreciation and amortization expenses. It is the cash a business can generate after spending the money required to run or expand it’s business.
There are two ways to calculate free cash flow.
- Operating Cash Flow – Capital Expenditures. It represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.
- EBIT(1-Tax Rate) + Depreciation & Amortization – Change in Net Working Capital – Capital Expenditure. Ex: EBIT is $10,000 adding back it D&A (+$3000) and we are at $13,000. The change in Net Working Capital is the change in current (non-cash) assets minus the change in current liabilities. Cap ex is the outlay of cash to capital investments.
A negative FCF is not necessarily undesirable. It happens when a company is making large capital investments.
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