Free cash flow
The cash left over after operating costs and capital expenditure, available for dividends, debt repayment or new investment.
Free cash flow is a key figure representing the cash a business generates once all operating costs and capital expenditure have been covered. It includes the money available after the necessary investment in the business's growth and maintenance, and so gives a clear picture of the company's ability to create a surplus, pay dividends, reduce debt or finance new investment. At its simplest, free cash flow reflects the amount of cash that is "free" to be used once all obligations have been met.
Why does free cash flow matter?
- Financial flexibility: A positive free cash flow gives businesses room to manoeuvre; it is an indicator that the company can invest in new projects, innovation and growth without depending on external financing.
- Attractiveness to investors: Investors often regard free cash flow as an important indicator of a company's financial health and its potential for long-term success.
- Ability to pay: The ability to generate a solid free cash flow ensures that the business can meet its short-term and long-term financial obligations, including debt repayments and dividends to shareholders.
How is free cash flow calculated?
Free cash flow can be calculated using the following formula:
Free cash flow = Cash flow from operating activities − Capital expenditure
Cash flow from operating activities: This is the cash generated from the business's ordinary trading activities.
Capital expenditure (CAPEX): This includes investment in physical assets such as buildings and equipment, which are needed in order to maintain or expand the business's operations.
Tips for improving free cash flow
- Optimise operating costs. Look for efficiencies in operations that can reduce costs and increase operating cash flow.
- Manage capital expenditure. Prioritise investments that give a high return, and avoid over-investing in capital-intensive projects that do not contribute to immediate growth.
- Improve working capital management. Managing inventory, trade receivables and trade payables effectively can release cash and improve free cash flow.
Read more about how Capassa gives you up-to-date forecasts for your free cash flow.
More terms in liquidity and cash flow
See all →Liquidity
How easily and quickly a company can turn assets into cash in order to meet its short-term obligations.
Current ratio (likviditetsgrad 1)
Measures current assets against current liabilities to assess the ability to meet short-term obligations.
Quick ratio (likviditetsgrad 2)
As the current ratio, but excluding inventory, giving a stricter measure of liquidity.
Cash ratio (likviditetsgrad 3)
Measures cash and cash equivalents alone against current liabilities, the strictest measure of liquidity.
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