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What is 'Free Cash Flow - FCF'

Free cash flow (FCF) represents the cash that a company is able to generate after required investment to maintain or expand its asset base. It is a measurement of a company's financial performance and health. There are two types of free cash flow: Free Cash Flow for the Firm (FCFF) and Free Cash Flow to Equity (FCFE). This item focuses on Free Cash Flow to the Firm (FCFF), otherwise understood as free cash flow or FCF.

BREAKING DOWN 'Free Cash Flow - FCF'

Free cash flow (FCF) are the cash flows available to all investors in a company, including common stockholders. FCF provides a useful valuation technique that can derive the value of a firm or the value of a firm's common equity.

FCF or FCFF in Company Analysis

FCF or FCFF measures the level of cash available to a company's investors net of all required investments in working capital and fixed capital, or capital expenditures (CAPEX), for a period. FCF or FCFF is an important measure because it allows a company to pursue opportunities that enhance shareholder value. Excess cash can expand production, develop new products, make acquisitions, pay dividends and reduce debt.

As free cash flow increases, balance sheet strength rises. However, it is important to note that negative free cash flow is not a bad indicator in itself. If free cash flow is negative, it could be a sign that a company is making significant investments. If these investments earn a high return, the strategy has the potential to add value in the long run.

FCF or FCFF Calculations

FCF or FCFF can be calculated in multiple ways. Frequently, the free cash flow (FCF) calculation begins with net income, but it can also be calculated by starting from Cash Flow From Operating Activities (CFO), Operating Income (EBIT), or EBITDA.

FCF or FCFF can be calculated via the following methods:

FCFF = Net Income + Net Non-cash Charges + (Interest Expense) * (1 - Tax Rate) - Capital Expenditures

FCFF = Cash Flow From Operating Activities (CFO) - Capital Expenditures

FCFF = EBIT * (1 - Tax Rate) + (Depreciation) + (Amortization) - (Change in Net Working Capital) - (Capital Expenditures)

FCFF = EBITDA * (1 - Tax Rate) + (Tax Rate) * (Depreciation + Amortization) - (Change in Net Working Capital) - (Capital Expenditures)

FCFF and FCFE are related through the following equation:

FCFE = FCFF - (Interest Expense) * (1 - Tax Rate) + Net Borrowing

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