The Free Cash Flow is the net amount of cash generated by the company, and available to repay debt, pay dividends to investors or expand the business. So, in other words, it is the remaining cash after deducting operational expenses, taxes, interests paid, and purchases of PP&E (CAPEX).
And if we breakdown the cash from operations, the formula is as follows:
In this link you can download a complete example of Free Cash Flow calculation. You will not find only the FCF itself, but also P&L, Balance Sheet and how all formula components are obtained from that statements.
- Net income: we can obtain it from the profit and loss statement. Basically, by including net income in our calculation, we are including all business revenues and expenses for a certain period of time. Alternatively, you can start the calculation from EBITDA (see below).
- (+) Depreciation and amortization: actually, we have to add not only the depreciation and amortization amount, but also all non-cash expenses. Depreciation and amortization is the most common non-cash expense in a business, but if you have any other else, it should be considered as well. By adding non-cash expenses, we are “correcting” the net income amount with all P&L expenses which did not mean a cash out.
- (-) Working Capital variation. In general, Working Capital is calculated as the difference between current assets and current liabilities. However, the items included inside current assets and current liabilities can vary. For our purpose, working capital will simply be calculated as: Stock + Account Receivable (trade and others) – Account Payables (trade and others). Therefore, we will not consider items like short-term financial liabilities or cash. By including Working Capital variation in the formula we are “adjusting” the net income with the timing effect of payments/collections vs. revenues/costs.
- (-) Purchases of PP&E (CAPEX). As this cash out is not included in Working Capital neither in Net income, it should be deducted.
Using EBITDA in FCF calculation
Alternatively, we can calculate FCF from EBITDA instead of using net profit as follows:
As EBITDA is a metric which includes depreciation and amortization, we do not have to add it in the formula; however, we should deduct interest and tax payments.