Understanding the Difference Between Free Cash and Free Cash Flow: A Comprehensive Guide

Cash is a critical element in the financial health of any business. However, the terms 'free cash' and 'free cash flow' are often used interchangeably, but in reality, they have distinct meanings. This article will clarify the differences and importance of these financial metrics, which are crucial for investors and business analysts.

Free Cash: The Basic Concept

.FC. (Free Cash) refers to unrestricted cash that is available for any use deemed appropriate by the management. This includes paying off debt, reinvesting in the business, paying dividends, or even distributing among other parts of the business. Typically, cash is only considered 'free' if it is not restricted or held in escrow. In accounting terms, cash on a balance sheet is only counted as free if it is unrestricted and available for any use by the management.

Free Cash Flow (FCF): The Detailed Metric

Free Cash Flow (FCF) is a non-GAAP (Generally Accepted Accounting Principles) metric that represents the cash flow from operations less capital expenditures. It is the residual cash that is available for distribution to investors after a company has paid for its ongoing operations and reinvestment needs. FCF is a key metric for assessing a company's financial strength and is used to determine the current value of a business.

Cash Flow vs. Cash

While cash is the actual currency or liquid assets that a business has, cash flow is a broader term that captures the inflow and outflow of cash over a specific period. Cash flow is used to find the net cash inflow from the business's basic activities, such as operating, investing, and financing. Conversely, Free Cash Flow (FCF) is the cash available for new investments after adjusting for working capital and other planned expenditures.

Calculating Free Cash Flow (FCF)

To compute FCF, the most comparable GAAP (Generally Accepted Accounting Principles) metric, Cash From Operating Activities (CFOA), is used. CFOA is then adjusted by subtracting capital expenditures (capex), which are expenses related to maintaining and upgrading physical assets (like buildings and machinery).

The calculation can be summarized as follows:

Cash From Operating Activities (CFOA) - Capital Expenditures (CapEx) Free Cash Flow (FCF)

Interpreting Free Cash Flow (FCF)

Free Cash Flow (FCF) is crucial for understanding a company's financial health and sustainability. It is used to define business valuation, which is essential for investors. FCF includes capital expenditures and changes in Net Working Capital, providing a more complete picture of the company's financial status.

Key Points to Remember

Finding the definition: You can find a definition of Free Cash Flow in annual reports or finance textbooks, often described as the part of the total cash flow that is not required for operations or reinvestment. Purpose of FCF: It is the part of the cash flow available for distribution among all the securities holders, including debt or equity, without hurting the company's operational capability or investment plan. Calculation: To calculate FCF, you take the most comparable GAAP metric, Cash From Operating Activities, and deduct capital expenditures.

Further Resources: For a more detailed look at Free Cash Flow, you can watch my YouTube video on Free Cash Flow. In the video, I will delve into common and alternative definitions of Free Cash Flow, compare the profit view and the cash flow view of a company's performance, and analyze FCF numbers published by companies such as Exxon Mobil, Facebook, General Electric, and General Motors.

If you have any questions or need further clarification, feel free to comment below. Happy investing!