Free Cash Flow (FCF)
The cash a company generates from operations after paying for the investment needed to maintain and grow the business. It is the money actually available for dividends, buybacks and debt repayment.
How to calculate it
Free cash flow (common definition) = net cash from operating activities − capital expenditures (purchases of property and equipment)FCF yield = free cash flow ÷ market capitalizationSome investors also subtract stock-based compensation: FCF after SBC = FCF − stock-based compensationHow to read it
- Positive and stable free cash flow over many years is what makes a dividend or buyback program sustainable. Persistently negative FCF means the company relies on borrowing or issuing stock to fund itself.
- If earnings rise every year while free cash flow stays negative, find out where the money is going and when those investments are supposed to pay off.
Common pitfalls
- Free cash flow is not a GAAP measure. Each company defines it, and some exclude items such as capitalized software, finance lease payments or acquisitions. Check the definition in the earnings release.
- Companies that pay heavily in stock look better on FCF than they are, because the stock-based compensation add-back is real economic cost paid in shares.
- A company in a heavy build-out phase can have negative FCF for good reasons. Treating all capital spending as 'money gone' undervalues growth investment.
- One large project can swing a single year. Look at three to five years combined. FCF does not apply to banks and insurers.
Where to find it in a 10-K
Statement of cash flows: operating cash flow, and 'Purchases of property and equipment' (or 'Capital expenditures') in the investing section. Companies that report FCF include a reconciliation in the earnings release because it is a non-GAAP measure.
U.S. vs. China reporting
Neither U.S. GAAP nor Chinese accounting standards define free cash flow, so the calculation is similar. The practical U.S. difference is stock-based compensation, which is far larger at many U.S. technology companies than at most A-share companies, making the choice between FCF and FCF after SBC much more important.