What Is EV/EBITDA? Definition and Example
What the EV/EBITDA multiple measures, how to calculate enterprise value and EBITDA, and when it beats the P/E ratio for comparing companies.
GlossaryGlossary
What Is Free Cash Flow? Definition and Example
What free cash flow is, how to calculate it from the cash flow statement, and why investors trust it more than reported earnings.
Key takeaways
- Free cash flow (FCF) is the cash a company generates from operations after paying for capital expenditures: operating cash flow minus capex.
- It is the money available for dividends, buybacks, paying down debt or acquisitions.
- FCF is harder to flatter with accounting choices than earnings, so a large, lasting gap between the two is a warning sign.
- FCF yield (FCF per share ÷ share price) is a common valuation check alongside P/E.
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What is free cash flow?
Free cash flow is what is left after a business pays its running costs and invests to maintain and grow its assets. Profits on the income statement include non-cash items; free cash flow shows the cash that actually came in.
How do you calculate free cash flow?
Free cash flow = cash flow from operations − capital expenditures. Both numbers are on the cash flow statement in a company’s 10-K or 10-Q. FCF yield = free cash flow ÷ market capitalization.
Worked example
Illustrative: two companies, each reporting $1.0B of net income.
| Measure | Company A | Company B |
|---|---|---|
| Net income | $1.0B | $1.0B |
| Cash flow from operations | $1.4B | $0.9B |
| Capital expenditures | $0.3B | $0.8B |
| Free cash flow | $1.1B | $0.1B |
| Market capitalization | $20B | $20B |
| FCF yield | 5.5% | 0.5% |
Same profit, very different cash. Company B needs nearly all its operating cash just to keep investing, so it has little left to return to shareholders.
Why it matters for a self‑directed investor
Dividends and buybacks are paid in cash, not earnings. If you own a stock for its dividend yield, check that free cash flow covers the dividend. FCF also fills the gap in EV/EBITDA, which ignores capex. See how to evaluate a stock idea.
Common mistakes
- Judging one year. Capex is lumpy; look at several years.
- Penalizing growth spending. Heavy capex can be an investment, not a weakness.
- Ignoring stock-based pay, which boosts operating cash flow while diluting shareholders.
Frequently asked questions
Yes. A company that spends more on capital projects than it generates from operations has negative free cash flow. That is common in fast-growing or struggling businesses.
It is harder to manage with accounting choices, so many investors use it as a check on earnings. Neither tells the whole story alone.
Free cash flow divided by market capitalization. It works like an earnings yield but uses cash instead of accounting profit.
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Educational content, not investment advice. Examples are illustrative; past performance does not guarantee future results.