Free cash flow: the cash the owners keep

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Key idea: Free cash flow is the cash left after running and maintaining the business. It is harder to dress up than reported profit.

Profit is an accounting figure. It includes estimates, such as how fast equipment wears out or when revenue counts as earned. Cash is simpler: it either came in or it did not.

Free cash flow (FCF) is cash from operations minus capital spending, the money spent on buildings, machines and equipment to keep the business going and growing. What remains is money that could be paid to owners, used to cut debt, or reinvested.

A company reporting steady profit but weak or negative free cash flow year after year deserves a closer look. Perhaps customers are paying late, stock is piling up in warehouses, or the business simply needs heavy spending just to stand still.

Divide free cash flow by the number of shares and you get FCF per share. Compare it with the price and you get the FCF yield, a cash-based cousin of the earnings yield from Day 3.

Quick check

A company has $900 million of cash from operations and spends $300 million on equipment. What is its free cash flow?

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