What Is Free Cash Flow?

Free cash flow is the cash a business generates after paying to maintain and grow its asset base. The core formula is cash from operations minus capital expenditure. Because it reflects money that actually moves rather than accounting profit, free cash flow is the foundation of discounted cash flow valuation and a sharper signal of financial health than net income.

Definition and the formula

The simplest definition is FCF = Cash Flow from Operations - Capital Expenditure. Cash from operations already includes the working capital adjustments and non cash addbacks, so subtracting capex leaves the discretionary cash that remains.

Capex appears in the investing section of the cash flow statement, so free cash flow draws on two sections at once. This is why it cannot be read off a single line of the financial statements.

Worked example in Excel

Suppose cash from operations is in B2 and capital expenditure, entered as a positive number, is in B3. Free cash flow is one subtraction.

1. Enter =B2-B3 in B4 to compute free cash flow.
2. Confirm capex is entered consistently. If it is stored as a negative outflow, use =B2+B3 instead so you are not double counting the sign.
3. Trace B2 back to net income plus non cash addbacks plus the change in working capital to make sure operations is built correctly.

=B2-B3 returns 200 - 70 = 130.

Levered versus unlevered FCF

Unlevered free cash flow, also called free cash flow to the firm, is the cash available to all capital providers before interest. It is the figure discounted in an enterprise value DCF.

Levered free cash flow, or free cash flow to equity, is what remains after interest and mandatory debt repayments. It belongs to shareholders alone.

• Unlevered FCF ignores financing and values the whole firm.
• Levered FCF subtracts interest and debt service and values just equity.
• Choosing the wrong one mismatches the cash flow with the discount rate and the valuation breaks.

Why it matters more than net income

Net income is an accrual figure shaped by non cash charges and accounting choices. A company can report rising profit while free cash flow falls, often because capex or working capital is quietly absorbing the cash.

Free cash flow is harder to dress up because it tracks money that moved. The common mistake is forgetting capex entirely, which inflates the figure and overstates value. Always confirm the capex line is present and has the right sign before trusting an FCF number.