Free Cash Flow (FCF) Formula
Free Cash Flow to equity
What is the Free Cash Flow (FCF) Formula?
The Free Cash Flow FCF Formula is equal to Cash from Operations minus Capital Expenditures. FCF represents the amount of cash generated by a business, after accounting for reinvestment in non-current capital assets and net increase/decrease in debt issued by the company. This figure is also sometimes referred to as Levered Free Cash Flow, or Free Cash Flow to Equity (FCFE).
Formula:
FCF = Cash from Operations – CapEx + Net Debt Issued
To learn more, read our ultimate cash flow guide now!
How to Derive the Free Cash Flow Formula
If you don’t have the cash flow statement handy to find Cash From Operations and Capital Expenditures, you can derive it from the Income statement and balance sheet. Below we will walk through each of the step required to derive the FCF Formula from the very beginning.
Step #1 Cash From Operations
Cash From Operations is net income plus any non-cash expenses, adjusted for changes in non-cash working capital (accounts receivable, inventory, accounts payable, etc).
Thus, the formula for Cash From Operations (CFO) is:
CFO = Net Income + non-cash expenses – change in non-cash net working capital
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Step #2 Non-Cash Expenses
We can further break down non-cash expenses into simply the sum an all items listed on the income statement that do not affect cash.
The most common items that do not affect cash are depreciation and amortization, stock-based compensation, impairment charges, and gains/losses on investments.
Thus, the formula for non-cash adjustments is:
Adjustments = depreciation + amortization + stock-based compensation + impairment charges + gains/losses on investments
Step #3 Changes in non-cash net working capital
Changes in non-cash net working capital is typically the most complicated step in deriving the FCF Formula, especially if the company has a complicated balance sheet.
The most common items that impact the formula (on a simple balance sheet) are accounts receivable, inventory and accounts payable.
Thus, the formula for changes in non-cash working capital is:
Changes = (2017 AR – 2016 AR) + (2017 Inventory – 2016 Inventory) – (2017 AP – 2016 AP)
Where,
AR = accounts receivable
AP = accounts payable
2017 = current period
2016 = prior period
Step #4 Capital Expenditures
It is possible to derive capital expenditures for a company without the cash flow statement. To do this, we can use the following formula with line items from the balance sheet and income statement.
Thus, the formula for capital expenditures is:
CapEx = 2017 PP&E – 2016 PP&E + Depreciation & Amortization
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Step #5 Net Debt Issued
From the balance sheet, we can get the opening and ending balances of debt to calculate the net debt issued by the company.
The formula for net debt issued is:
Net Debt Issued = Ending Debt Balance – Opening Debt Balance
Step #6 Combining the components of the FCF Formula
We can combine the above four steps into one long FCF formula.
The Full FCF Formula is equal to:
FCF = Net Income + [depreciation + amortization + stock-based compensation + impairment charges + gains/losses on investments] – [(2017 AR – 2016 AR) + (2017 Inventory – 2016 Inventory) – (2017 AP – 2016 AP)] – [2017 PP&E – 2016 PP&E + Depreciation & Amortization] + (Ending Debt Balance – Opening Debt Balance)
In practical terms, it would not make sense to calculate FCF all in one formula. Instead, it would usually be done as several separate calculations, as we showed in the first 4 steps of the derivation.
The simplified formula is:
FCF = Cash from Operations – CapEx + Net Debt Issued
What is Free Cash Flow vs Unlevered Free Cash Flow?
When corporate finance professionals refer to Free Cash Flow, they also may be referring to Unlevered Free Cash Flow, or Free Cash Flow to the Firm (FCFF).
The difference between regular Free Cash Flow and Unlevered Free Cash Flow is that regular FCF includes the company’s interest expense and net debt issued, whereas the unlevered version backs out the interest expense and makes an estimate of what taxes would be without the interest expense.
To learn more, see our guide on FCF vs Unlevered FCF.
The FCF Formula in Financial Modeling and Valuation
When it comes to financial modeling and performing company valuations in Excel, most analysts use unlevered FCF. They will typically create a separate schedule in the model where the break down the calculation into simple steps and all components together.
Below is an example of the unlevered FCF calculation from a real financial model.
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More Relevant Resources
We hope this has been a helpful guide to understanding the FCF formula, how to derive it, and how to calculate FCF yourself.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: