Free Cash Flow
Free cash flow (FCF) is the cash a company generates from its operations minus what it spends on capital expenditures. It measures the cash actually available to shareholders and creditors after the business has funded itself.
The math
A company reports 100 million dollars of operating cash flow and spends 30 million on capital expenditures: 70 million of free cash flow. Now compare it to reported profit.
If that company shows 90 million of net income but only 20 million of FCF year after year, roughly 70 million of paper profit never turns into money. At 20 times earnings, you are effectively paying 90 times the cash the business actually produces.
| Net income | Free cash flow | |
|---|---|---|
| Reported each year | $90M | $20M |
| Multiple at the same price | 20x | 90x |
The trap
Assuming positive earnings mean positive cash. Aggressive revenue recognition, ballooning receivables, and inventory build-ups all inflate earnings while cash quietly drains.
A persistent gap between rising net income and flat or negative free cash flow is one of the most reliable red flags in equity analysis, and it is invisible if you only read the income statement.
The move
Track FCF over five years or more, not one: capital-intensive businesses alternate heavy investment years and harvest years. Relate it to price with free cash flow yield (FCF divided by market cap) to compare stocks against each other and against bonds.
Then check what management does with the cash: reinvestment at high returns, debt paydown, buybacks below intrinsic value, or empire-building acquisitions. The use of free cash flow is where a good business becomes a good investment, or stops being one.