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Free cash flow

Category — Financial Statements
Free cash flow (FCF) is a financial measure that reflects the cash that an organization has left after all of its capital expenditures to maintain assets.

Free cash flow is an important indicator for investors, creditors, and shareholders, as it gives an idea of how much money a company can earn over a certain period in the course of its activities. The company can use this money to pay dividends, pay off debt, invest in securities, and buy back its own shares.

In practice, there are three main methods for calculating free cash flow.

Method 1. FCF = Net Operating Cash Flow – Capital Expenditure (CAPEX)

This is one of the most common and simplest ways to calculate free cash flow. Companies, when preparing their financial statements in IFRS format, as a rule, use this particular method of calculation.

Using the IFRS financial statements of the Austrian company Telekom Austria AG as an example, you can see how the company’s free cash flow has changed, calculated by the first method, since 1998 (data are presented in thousand EUR).

Method 2. FCF = EBITDA – Paid Income Tax – CAPEX – Changes in Net Working Capital (NWC)

This method is more detailed and reveals the reasons for the change in the organization’s free cash flow. A similar method for determining FСF is used, for example, by Severstal.

Method 3. FCF = EBIT * (1 – Income Tax Rate) + Depreciation – CAPEX – Changes in Net Working Capital

This method of determining free cash flow is predictive, and, unlike the two previous methods, an income tax rate is used here, which may change from time to time.

Free cash flow can be positive or negative. A negative value indicates that the company spends more money than it earns. FCF should not be confused with net cash flow (NCF), which is calculated as the sum of the net cash flows generated from a company’s operating, investing, and financing activities.

The indicator of free cash flow can be used to assess the financial stability of an organization; for example, there is a ratio of FCF to operating cash flow. The higher the value of this indicator, the greater the financial stability of the company.
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