What is free cash flow?

Free cash flow is the cash a company has left over after covering all its expenses. Free cash flow includes operating costs like payroll, equipment, rent, and insurance, as well as the cost of maintaining current assets and meeting other financial obligations.

Why is free cash flow important for valuation?

Free cash flow plays an essential role in valuation as it shows how much capital a company has available to invest in growth, pay off its debts, or return dividends to investors, which is an indicator of financial health that investors use to determine its present value.

What are the differences between free cash flow and EBITDA?

EBITDA is a measure of a company’s operating performance and profitability, excluding taxes, depreciation, and amortization. It’s often used to compare performance across businesses, as it strips out certain non-operating expenses. Free cash flow (FCF), on the other hand, shows the actual cash generated from operations—what’s left after covering capital expenditures. This is the cash available for reinvestment, debt repayment, or dividends. While EBITDA highlights operating efficiency, FCF offers a clearer view of a company’s ability to generate and manage cash in real terms.

How does working capital affect free cash flow?

Working capital measures a company’s short-term financial health by comparing assets and cash inflows—like accounts receivable—against liabilities and outflows, such as accounts payable. It reflects the company’s ability to meet short-term obligations. When calculating free cash flow, changes in working capital are key. Shifts in accounts receivable or payable can reduce free cash flow, since more cash may be tied up in daily operations. Understanding these changes helps give a clearer picture of how much cash is actually available for reinvestment or other strategic decisions.