Free cash flow

This belongs with the financial statement ratios. A large number of publicly traded companies are now using free cash flow or a variation of it as a measure of performance. In some manner this is a better indication of a company’s profitability than the more typical measures.

Free cash flow shows how much cash a business generated that can be used for expansion, developing new products, reducing debt, or for payments to shareholders either with dividends or by repurchasing stock. When you think about it, how else would you measure profitability or operations?

Free cash flow is the operating cash flow less capital expenditures. The operating cash flow comes from the top of, or first section of, the statement of cash flows. This is the net income devoid of noncash income and deductions adjusted for changes in the working capital components. The reduction for capital expenditures represents the reality that most businesses with equipment are continuously adding additional equipment making that a normal recurring expenditure. EBITDA, a widely used measure is clearly off the mark and in my opinion irrelevant. Free cash flow compensates for this fatal shortcoming.

I would further adjust a company’s free cash flow by removing any unusual and nonrecurring gains or losses.

To better understand free cash flow I suggest reviewing Forms 10-K for companies you own stock in and seeing its treatment. Some 10-Ks I reviewed have four or five iterations of free cash flow. This is another measure to use when evaluating a company. The more appropriate data you get the better will be your decision.

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