What Is Free Cash Flow? 3 Formulas To Calculate Free Cash Flow?
Hello friends, today again, I am brought you a new topic related to the stock market. Today we will know what is free Cash Flow? In this blog, we will understand the basics of free cash flow.
In this blog, we will learn the easiest way how to calculate free cash flow. I will discuss some simple formula that you can also calculate free cash flow. After reading this blog today, you will understand what is the free cash flow.
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Free CashFlow or FCF is an essential tool to judge the quality of the company. Free cash flow helps in forensic analysis of the actual health and cash flows of the firm or the company. Understand what is free cash flow and how to calculate free cash flow along with examples of how free cash flow (FCF) analysis helps you in picking better stocks.
What is free cash flow:
Free cash flow may be different from net income, as free cash flow takes into account the purchase of capital goods and changes in working capital.
We understand this with an example. Suppose you have ₹ 20 and you buy two pencils from that ₹ 20 and on selling a pencil for ₹ 15 you got ₹ 30. Thus, you got a profit of 10 rupees in a day. Here you get free cash flow of 10 rupees.
All businessmen put their maximum profit in their business to enhance their business. If you are getting whatever profit from your business, if you are investing all those profits in your business then your free cash flow is zero. Meaning that whatever money you are saving from your business is called your free cash flow.
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Friends, there are three factors of free cash flow.
1. Cash from operating profit:
The amount of cash that is generated from the core business of any company is called cash operating profit. In this, how much cash is going to come in your account, it is not necessary, but how much cash has come in your account, it is necessary.
2. Working Capital Change:
Current assets – current liability.
Where current asset means any assets that we can sell immediately and generate liquidity. And Current Liability means the liability which is going to be matured in only one year or which we have to repayment in the next one year, then such liability is called current liability.
If you get a profit then you will have to pay tax. This tax will also be called your case flow.
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How to calculate the free cash flow:
Free cash flow can be calculated in various ways, depending on the audience and available data. A common measure is to take the earnings before interest and taxes multiplied by 1 − tax rate, add depreciation and amortization and then subtract changes in working capital and capital expenditure. Depending on the audience, a number of refinements and adjustments may also be made to try to eliminate distortions.
Free Cash Flow Formula Starting With EBIT:
1) Free Cash Flow to Firm or FCFF = EBIT x (1-tax rate) + Non Cash Charges + Changes in Working capital – Capital Expenditure
2) FCFF FORMULA STARTING WITH NET INCOME
Net Income + Depreciation & amortization Interest x (1-tax) + changes in Working Capital – Capital Expenditure
3) FCFF FORMULA STARTING WITH EBITDA
EBITDA x (1-tax rate) + (Dep & Amortization) x tax rate + changes in Working Capital – Capital Expenditure.
All FCFF formula have the same results. My personal favorite is the Free Cash Flow Formula that starts with EBIT. The primary reason is when we do financial modeling, it is easier to forecast and normalize EBIT and take the relevant EBIT into the free cash flow.
Friends, I hope you understand what is free cash flow. If you still have doubts related to free cash flow, then you can contact us.