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FREE CASH FLOW


 

Free cash flow for a firm is the cash that company generates through its operations less cost of capex. In other words FCF is the cash left over after capex and operational expenses. It is one the crucial parameter for investors before investing in the company. A company with plenty of FCF implies its capability to pay debts, dividends, buyback shares and also to facilitate the growth of firm. Unlike net income which is easy to manipulate FCF is difficult to tweak and acts as crucial parameter in valuating company profitability. A negative FCF need not simply imply downturn of the firm but if the firm has actually undergone huge investments for better returns on the long term. A positive FCF imply that the firm is generating more cash than      that used to run the company, in other terms profitability.

The capex will usually last for more than a year thus costly when they incur in FCF. This makes FCF itself different from year to year. Firms can also boos FCF by stretching payments, decreasing inventories and increasing trade receivables TAT. While interpreting the FCF, one should also check if firms are underreporting capex and R&D expenses. Thus from an investor’s perspective FCF if accurately calculated can prove the profitability of the firm. To value the company effectively, projected FCF is discounted at the WACC (Weighted Average Cost of Capital).

FCF can be reported either to the firm as a whole or to the equity. FCFF (Free cash flow to firm) considers cash available for stock and bond holders put together while FCFE is the cash available to the equity holders after meeting bonds/debts expenses. Out of these two FCFF is more suitable for firm with high leverage. Overall it can be concluded that FCF gives effective profitability of the firm while valuating company from investor’s perspective.

 

 

 

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