Definition:

Free Cash Flow / Net Income is a financial metric that compares a company's free cash flow to its net income, providing insight into the quality of earnings and the efficiency of cash generation relative to reported profits.

Formula:

Free Cash Flow / Net Income = Free Cash Flow / Net Income

How to use the metric:

This metric is used to assess how effectively a company converts its net income into free cash flow. A ratio greater than 1 indicates that the company is generating more cash than its reported net income, which is generally positive. Conversely, a ratio less than 1 may suggest that net income is not fully translating into cash flow, potentially due to high capital expenditures or working capital requirements.

Limitations:

The metric can be affected by non-cash accounting items, one-time charges, or changes in working capital, which may distort the comparison between free cash flow and net income. It may not provide a complete picture of financial health if used in isolation.

Applies to:

This metric is particularly useful in capital-intensive industries such as manufacturing, utilities, and telecommunications, where cash flow management is critical.

Doesn't apply to:

It may be less applicable to industries with volatile cash flows or significant non-cash accounting adjustments, such as technology startups or financial services, where net income and cash flow can diverge significantly.

Summary:

Free Cash Flow / Net Income is a valuable metric for evaluating the quality of a company's earnings and its ability to generate cash. While it provides useful insights, it should be used alongside other financial metrics to gain a comprehensive understanding of a company's financial performance.