Free Cash Flow

Overview of Free Cash Flow
Free cash flow is an important concept in the context of corporate finance. Generally the free cash flow is supposed to be allotted to those who hold securities in a business organization. It could also be defined as the amount of cash, which a company holds after it spends the money needed to keep or enlarge the base of assets.

Recipients of Cash Flow
Normally the following people receive a part of the free cash flow of a company:

Holders of Convertibles
Equity Holders
Holders of Preferred Stock
Debt Holders

Use of Free Cash Flow
Free cash flow could be used for calculating the following:

The lower expenditures that are needed to retain the assets. These expenditures are also termed the capex or capital expenditures
The operating cash flow. The operating cash flow also includes the interest reduction
Mathematical Calculation of Free Cash Flow
Free cash flow can be calculated by using the following formula:

Free cash flow = Net income + Amortization / Depreciation � Capital Expenditures – Changes in Working Capital.

Free cash flow can also be measured by subtracting capital expenditures from operating cash flow.
Alternative Numerical Representation of Free Cash Flow
Following is the alternative numerical representation of free cash flow:

FCFt = OCBt � It

In this formula:

It = Investment made by a particular firm in the period t. It also includes the variation of the working capital
OCBt = Net operating profit of the company after it has paid its taxes in the period t

In this case, investment is primarily either the net decrease or increase of the capital of a particular firm calculated in between two successive time periods. The equational representation of Investment is:

It = Kt � Kt-1

In this equation:

Kt = Capital invested by a firm after the conclusion of the period t.

The rise of current assets of a company that are non-cash may or may not be deduced. The deduction of such assets is done on the basis of the following points:

The assets are being used as investments that are meant for growth
The assets are being conceived for retaining the same situation
Unlevered Free Cash Flow
The unlevered free cash flow is actually the cash flow before a company pays off the interest. It is normally specified as the alteration in a business entity’s net working capital.

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Last Updated on : 1st July 2013

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