Free Cash Flow

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Explanation of Free Cash Flow.

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The Free Cash Flow method is an expression of the amount of cash that is available for the stockholders.


Free Cash Flow Calculation


      Net Operating Profit

-     Taxes

------------------------------------------------------

=    NOPAT


-     Net Investment

-     Net Change in Working Capital

------------------------------------------------------

=   Free Cash Flow


How do corporations earn money?

They earn money by operating business units where it manufactures products or provides services. A company generates revenue by selling its products and services to another party. In generating revenue, a company incurs expenses - salaries, cost of goods sold (CGS), selling and general administrative expenses (SGA), research and development (R&D). The difference between operating revenue and operating expense is Operating Income or Net Operating Profit.


The cost of Capital, taxes and Free Cash flow

To produce revenue a firm not only incurs operating expenses, but it also must invest money in real estate, buildings and equipment, and in working capital to support its business activities. Also, the corporation must pay income taxes on its earnings. The amount of cash that's left over after the payment of these investments and taxes is known as Free cash flow (Free Cash Flow).


The use of Free Cash Flow

Free cash flow (Free Cash Flow method) is an important measurement for shareholders. The cash that remains after the payment of all cash expenses and operating investment required by the firm. It is the money that is available to pay the company's various claim holders, in particular the shareholders.


Book: S. David Young, Stephen F. O'Byrne - EVA and Value-Based Management: A Practical Guide.. -

Book: Aswath Damodaran - Investment Valuation: Tools and Techniques.. -

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -


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Compare with: Discounted Cash Flow (DCF)  | Internal Rate of Return (IRR)  |  Management Buy-out  |  Cost-Benefit Analysis  |  Total Cost of Ownership


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