Free Cash Flow (FCF)

The basic definition

FCF = Cash from Operations − Capital Expenditures. Cash from Operations comes off the cash flow statement (already adjusted for non-cash items and working capital changes). Capital Expenditures are amounts spent on property, plant, and equipment.

Variants exist: Free Cash Flow to the Firm (FCFF) adds back interest expense × (1 − tax rate); Free Cash Flow to Equity (FCFE) starts from FCFF and subtracts net debt repayments. For owner-operators, the simple operating-cash-flow-minus-capex definition is what matters.

Why analysts prefer it to net income

Net income includes non-cash items (depreciation), excludes capital investment, and is sensitive to accounting choices. FCF is largely choice-free — you either spent the cash or you didn't.

DCF (discounted cash flow) valuation uses projected FCF as its core input. Most public-company analysts publish FCF estimates separately from EPS estimates because the two can diverge meaningfully and FCF correlates better with long-term value creation.

FCF variants and which to use

There are three commonly used variants. Free Cash Flow to the Firm (FCFF) is operating cash flow minus capex and is independent of capital structure — used in DCF valuation and enterprise-value comparisons. Free Cash Flow to Equity (FCFE) is FCFF minus net debt repayment and is what's actually available to equity holders. Owner's earnings (Buffett's variant) is similar to FCFF but more conservative on maintenance capex.

For owner-operated businesses, the most useful variant is usually FCFF or owner's earnings — what cash the operations generate after maintaining the asset base. This is the number that determines whether the business can self-fund growth, distribute to owners, or service debt without further equity contribution.

Be careful about working-capital movements in FCF. A business that's growing fast can have high reported earnings and low FCF because working-capital expansion absorbs the cash. That's not a quality-of-earnings problem if growth is real; it's just the cost of growth. A business with declining FCF and stable revenue, on the other hand, often signals either capex catch-up or working-capital deterioration that's quietly using cash.

Boards of high-growth companies often look at FCF margin trajectory rather than the absolute number — a business going from -50% FCF margin to -10% over four quarters is on a clear path to self-funding, even though it's still consuming cash. Tracking the trend with a credible plan for when it crosses zero is much more useful than benchmarking the current quarter against an arbitrary target.