Definition:

Free Cash Flow (FCF) is the amount of cash generated by a company after accounting for capital expenditures needed to maintain or expand its asset base. It represents the cash available for distribution among all the securities holders of a corporate entity.

Formula:

FCF = Operating Cash Flow - Capital Expenditures

How to use the metric:

Free Cash Flow is used by investors and analysts to assess a company's financial health and its ability to generate cash. It is a key indicator of a company's ability to pay dividends, buy back shares, pay down debt, or reinvest in the business. A positive FCF indicates that a company has sufficient cash to pursue growth opportunities, while a negative FCF may signal financial difficulties.

Limitations:

Free Cash Flow can be volatile and may not provide a consistent measure of a company's financial performance. It can be influenced by one-time events or changes in working capital. Additionally, FCF does not account for non-cash expenses or changes in a company's debt structure, which can affect the overall financial picture.

Applies to:

Free Cash Flow is applicable across various industries, particularly those with significant capital expenditures such as manufacturing, utilities, and telecommunications. It is useful for companies where cash flow management is critical to operations and growth.

Doesn't apply to:

Free Cash Flow may be less relevant for industries with minimal capital expenditures, such as software or service-based companies, where other metrics like EBITDA might provide a better financial picture. Additionally, startups or high-growth companies that are reinvesting heavily in their business may show negative FCF, which doesn't necessarily indicate poor financial health.

Summary:

Free Cash Flow is a crucial financial metric that provides insight into a company's ability to generate cash after capital expenditures. It helps investors and analysts evaluate a company's financial health and its capacity to support growth, dividends, and debt repayment. However, it has limitations and may not be suitable for all industries, particularly those with low capital expenditure requirements or high-growth startups reinvesting in their operations.