Free Cash Flow

Free Cash Flow (FCF) is a financial metric that measures how much cash a company creates during a certain period of time that can be used to repay debt, pay dividends, acquire other companies, or make other investments. Free cash flow is the net amount of cash flow generated by a company's operating activities minus capital expenditure (CAPEX). Capital expenditure refers to the fixed assets purchased by enterprises to maintain or increase production capacity, such as machinery, equipment, land, buildings, etc.

The formula for calculating free cash flow is:

FCF = Operating Cash Flow (OCF) - CAPEX

Operating cash flow refers to the cash difference between a company's income and expenses from its main business activities, reflecting the company's core profitability. Operating cash flow can be calculated from the income statement by adding net income (Net Income) to non-cash items (such as depreciation, amortization, inventory changes, etc.) and changes in working capital (such as accounts receivable, accounts payable wait).

CAPEX refers to the cash paid by an enterprise to increase or update its fixed assets within a certain period of time, reflecting the level of investment in the enterprise's growth. CAPEX can be found from the cash flow statement, usually listed in the investing activities section.

Free cash flow is an important financial metric because it reflects a business's true profitability and growth potential. A stable or growing free cash flow means that the business has enough cash to pay its necessary expenses and pay down its debt, and has room to distribute to shareholders or make other valuable investments. On the contrary, a negative or declining free cash flow means that the company's cash is insufficient to meet its financial obligations and development needs, and it may need to increase debt or issue new shares to raise funds, which will reduce the value and credit rating of the company.

Free cash flow can also be used to assess the value and attractiveness of a business. Generally speaking, the value of a business is equal to the sum of the discounted value of all its future free cash flows. The discount rate depends on the risk and cost capital of the business. Therefore, a business with high free cash flow is generally more valuable and competitive than a business with low free cash flow. In addition, free cash flow can also be used to calculate the company's free cash flow yield (Free Cash Flow Yield), which is free cash flow divided by market value (Market Value), which is a ratio that measures the relative price and profitability of a company. A business with a high free cash flow yield is generally considered to be undervalued or inefficient, while a business with a low free cash flow yield is generally considered to be overvalued or inefficient.

How to improve free cash flow?

Improving free cash flow is important for any business that wants to increase its value and competitiveness. There are two basic ways to improve free cash flow: increase operating cash flow or reduce CAPEX.

Increasing operating cash flow can be achieved by increasing sales revenue, reducing costs, improving inventory management, speeding up collections, delaying payment times, etc. These measures can improve a company's profit margins and asset turnover, thereby increasing its core profitability and cash generation capabilities.

Reducing CAPEX can be achieved by extending the service life of fixed assets, improving the utilization rate of fixed assets, selecting investment projects with lower costs or higher returns, and outsourcing non-core businesses. These measures can reduce the company's growth investment level and fixed costs, thereby saving cash that can be used for other purposes.

Of course, improving free cash flow doesn't mean giving up investment or growth entirely. A successful business needs to find a balance between maintaining its current competitive advantage and creating future growth opportunities. Therefore, when deciding how to increase free cash flow, various factors need to be taken into consideration, such as market demand, industry trends, competitors, risk appetite, etc.

Conclusion

Free cash flow is a financial indicator that reflects a company's true profitability and growth potential. It is also an important basis for evaluating a company's value and attractiveness. Improving free cash flow is very important to increase corporate value and competitiveness. There are two main methods: increasing operating cash flow or reducing CAPEX. However, when improving free cash flow, various internal and external factors also need to be taken into consideration to achieve the best results.