Free Cash Flow is the amount of cash a business generates after accounting for capital expenditures such as buildings or equipment. This cash can be used for expansion, dividends, reducing debt, or other purposes. The formula for free cash flow is:
The data needed to calculate a seller’s free cash flow is usually on its cash flow statement. It is important to note that free cash flow relies heavily on the state of a seller’s cash from operations, which in turn is heavily influenced by the seller’s net income. Thus, when a seller has recorded a significant amount of gains or expenses that are not directly related to the seller’s normal core business (a one-time gain on the sale of an asset out of the ordinary course, for example), it may very well be appropriate to exclude it from the free cash flow calculation to get a better picture of the seller’s normal cash-generating ability.
Generally, free cash flow might be influenced or manipulated by lengthening the time taken to pay bills, shortening the time it takes to collect accounts receivables, or delaying the purchase of inventory.