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Free cash flow is the amount of cash a business has left over after it pays for capital expenditures, like equipment or buildings, and expenses. A positive free cash flow means the company is making more money than it’s using; a negative one means the company is not generating enough money to support itself.

Free cash flow can measure a business’s performance as if you’re looking at its net income line. The widely used price-to-earnings ratio implies the curent market's assessment of the company by looking at multiple. But the cash flow statement is a better measure of company performance than the income statement because it uses free cash flow.

The most common way to calculate free cash flow yield is to divide a company’s free cash flow by its market capitalization, which is the number of its outstanding shares multiplied by its share price.

Another way to calculate it is a company’s free cash flow divided by its enterprise value, which is its market capitalization plus debt, minority interest and preferred shares, minus cash and cash equivalents.

Both methods give investors a valuable tool. The market capitalization ratio works best when compared to the P/E ratio. Enterprise value lets investors compare companies across different industries, or with different capital structures.

While investors should include free cash flow yield among their financial measures, they should not depend exclusively on any one measure.

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