What is Free Cash Flow?
About this lesson
In this video, I will explain Free cash flow to the firm by showing a simple numeric example. Free cash flow to the firm (FCFF) represents the amount of cash flow from operations available for distribution after depreciation expenses, taxes, working capital, and investments are accounted for and paid.
What free cash flow is
Free cash flow to the firm (FCFF) is the cash a company’s operations generate after paying taxes and making the investments it needs to keep running and growing. It’s the cash available to all investors: lenders and shareholders.
Because it’s cash, not accounting profit, it’s the starting point of most company valuations.
The formula
FCFF = EBIT × (1 − t) + Depreciation − Capital expenditures − Increase in net working capital
- EBIT × (1 − t): operating profit after tax.
- + Depreciation: a non-cash expense, so it’s added back.
- − Capital expenditures: spending on new equipment and buildings.
- − Increase in net working capital: cash tied up in inventory and receivables as the business grows.
Example
| Item | Amount |
|---|---|
| EBIT | $1,000 |
| Tax rate | 25% |
| Depreciation | $200 |
| Capital expenditures | $300 |
| Increase in net working capital | $50 |
FCFF = 1,000 × (1 − 0.25) + 200 − 300 − 50 = 750 + 200 − 350 = $600
FCFF vs FCFE
Free cash flow to equity (FCFE) is what’s left for shareholders only, after paying lenders:
FCFE = FCFF − Interest × (1 − t) + Net borrowing
- Discount FCFF at the WACC to value the whole firm.
- Discount FCFE at the cost of equity to value the shares directly.
For a full worked valuation, read the discounted cash flow (DCF) model.