Free cash flow (FCF): Definition and how to calculate it
- What is free cash flow (FCF)?
- How to calculate free cash flow
- Why free cash flow matters for your business
- How to interpret free cash flow results
- Free cash flow vs. other financial metrics
- Benefits of tracking free cash flow
- Limitations of free cash flow analysis
- How to improve your free cash flow
- Improve free cash flow with automated spend controls and real-time visibility
Free cash flow (FCF) is the cash your business has left after covering operating expenses and capital expenditures (CapEx). It shows how much money you can use to pay down debt, return cash to shareholders, or reinvest in growth.
Because it focuses on actual cash, not accounting profit, FCF is one of the clearest indicators of financial health and long-term sustainability.
What is free cash flow (FCF)?
Free cash flow is the cash your company generates after covering operating expenses and capital expenditures (CapEx). It represents the discretionary cash you can use to reduce debt, return capital to shareholders, or reinvest in the business.
Unlike net income, which includes non-cash expenses such as depreciation and amortization, free cash flow reflects the cash that actually moves through your business. That makes it a more practical measure of liquidity and financial flexibility.
Finance teams track FCF to assess sustainability and performance. For example, you might show rising revenue on the income statement but still generate negative free cash flow if accounts receivable grow faster than collections or if heavy CapEx absorbs cash.
Consistently positive free cash flow gives you options. You can use FCF to:
- Pay dividends: Distribute profits to shareholders
- Reduce debt: Strengthen your balance sheet and lower interest costs
- Fund expansion: Invest in new products, markets, or capacity without external financing
- Build reserves: Create a buffer to manage downturns or unexpected expenses
Tracking free cash flow helps you understand your company’s true financial position and make informed decisions about growth, risk, and capital allocation.
How to calculate free cash flow
You calculate free cash flow by subtracting capital expenditures (CapEx) from operating cash flow.
Free cash flow = Operating cash flow – Capital expenditures (CapEx)
Operating cash flow comes from your cash flow statement and reflects cash generated from core operations. CapEx represents investments in long-term assets such as property, plant, and equipment (PP&E).
1. Determine operating cash flow
Find operating cash flow on your cash flow statement under “cash from operating activities.” This figure already adjusts for non-cash expenses such as depreciation and amortization, along with changes in working capital like accounts receivable and accounts payable.
Operating cash flow shows how much cash your core business generates before investment spending.
2. Identify capital expenditures
Locate capital expenditures in the investing section of your cash flow statement. CapEx includes purchases of property, equipment, software, and other long-term assets used to maintain or grow operations.
These investments support future growth but reduce available cash in the current period.
3. Subtract CapEx from operating cash flow
Subtract total CapEx from operating cash flow to determine free cash flow.
For example, if operating cash flow is $500,000 and CapEx is $150,000, then:
Free cash flow = $500,000 – $150,000 = $350,000
That $350,000 represents the cash available for debt repayment, dividends, reinvestment, or reserves.
Calculating FCF from net income
If you don’t have a full cash flow statement, you can calculate free cash flow using your income statement and balance sheet:
Free cash flow = Net income + Depreciation and amortization – Changes in working capital – CapEx
This method starts with net income and adjusts for non-cash expenses and working capital changes. An increase in working capital reduces cash, while a decrease frees up cash.
For example:
- A $50,000 increase in accounts receivable reduces FCF because cash hasn’t been collected
- A $20,000 increase in accounts payable increases FCF because cash remains in your business longer
Finance teams often use this approach in forecasts and financial models when projecting income statement and balance sheet data.
Why free cash flow matters for your business
Free cash flow shows whether your business generates enough cash to operate, invest, and grow without relying on external financing. It reflects financial resilience more clearly than accounting profit.
- Financial flexibility: Positive FCF gives you room to handle unexpected expenses or economic slowdowns without taking on additional debt
- Growth potential: Strong FCF lets you invest in new products, markets, or acquisitions using internal cash instead of diluting ownership
- Valuation tool: Free cash flow underpins discounted cash flow (DCF) models, which investors use to estimate what your business is worth
- Investor confidence: Consistent positive FCF signals strong fundamentals and an ability to generate sustainable cash
When you track free cash flow consistently, you gain a clearer view of your company’s long-term stability and strategic options.
How to interpret free cash flow results
Free cash flow only becomes meaningful when you interpret it in context. The same number can signal strength or risk depending on your company’s stage and strategy.
Positive free cash flow
Positive free cash flow means your business generates more cash than it spends on operations and capital investments. In most cases, this signals financial stability.
You can use surplus cash to reduce debt, fund expansion, repurchase shares, or build reserves. Consistent positive FCF gives you flexibility and reduces reliance on outside financing.
Negative free cash flow
Negative free cash flow means your cash outflows exceed operating inflows after CapEx. That isn’t automatically a red flag.
High-growth companies often invest heavily in equipment, technology, or expansion, which temporarily drives negative FCF. It becomes concerning when negative FCF persists without clear revenue growth or a defined investment strategy.
FCF for growth companies vs. mature businesses
Your growth stage matters when evaluating FCF. Early-stage or high-growth companies may intentionally accept negative FCF while scaling operations.
Mature businesses, however, should generally generate steady positive FCF. If an established company consistently fails to produce excess cash, it may indicate operational inefficiencies, margin pressure, or structural cash flow issues.
Free cash flow vs. other financial metrics
Free cash flow differs from profit-based metrics because it shows the cash left after operating expenses and capital expenditures. Other metrics may indicate profitability, but they don’t tell you how much cash is actually available.
| Metric | What it measures | Key difference from free cash flow |
|---|---|---|
| Net income | Accounting profit including non-cash items | Includes depreciation and accruals; does not reflect actual cash movement |
| Operating cash flow | Cash generated from core operations | Does not subtract capital expenditures |
| EBITDA | Earnings before interest, taxes, depreciation, and amortization | Ignores working capital changes, interest, and capital expenditures |
Free cash flow vs. net income
Net income reflects profitability under accounting rules, not actual cash availability. A company can report strong net income while struggling with liquidity if receivables increase or capital spending is high.
Free cash flow focuses strictly on cash remaining after operational and investment needs.
Free cash flow vs. operating cash flow
Operating cash flow measures cash generated from day-to-day business activities. It adjusts for working capital changes and non-cash expenses, making it more reliable than net income.
However, it stops short of subtracting capital expenditures. Free cash flow goes one step further by accounting for investment spending.
Free cash flow vs. EBITDA
EBITDA is often used for quick performance comparisons across companies. It excludes interest, taxes, depreciation, and amortization.
Because EBITDA ignores working capital needs and capital expenditures, it can overstate the cash available in your business. Strong EBITDA does not guarantee strong free cash flow.
Benefits of tracking free cash flow
Tracking free cash flow gives you a clearer view of how much cash your business can actually deploy. It helps you move beyond accounting profit and make decisions based on liquidity and sustainability.
Evaluating your cash position
Free cash flow shows how much cash remains after operating expenses and capital investments. Even if your income statement shows strong earnings, FCF confirms whether those earnings translate into usable cash.
Supporting investment decisions
Before committing to expansion, new equipment, or acquisitions, you need to know whether you can fund the investment internally. Free cash flow helps you determine if you can self-finance growth or if you’ll need outside capital.
Planning debt repayment
Lenders often evaluate free cash flow when assessing creditworthiness. Tracking FCF helps you schedule debt repayments without constraining operations or risking short-term liquidity.
Guiding dividend distributions
Sustainable dividends depend on sustainable cash generation. Free cash flow shows whether distributions are supported by excess cash or funded through borrowing.
Informing business valuation
Free cash flow is central to valuation models, particularly discounted cash flow analysis. Whether you’re raising capital, planning a sale, or benchmarking performance, FCF provides a foundation for determining enterprise value.
Limitations of free cash flow analysis
Free cash flow is a powerful metric, but it doesn’t tell the full story on its own. Misinterpreting short-term swings or one-time investments can lead to flawed decisions.
Volatility and timing distortions
Free cash flow can fluctuate significantly based on payment timing. Seasonal shifts in accounts receivable and accounts payable can create large swings between periods.
For example, retailers may show negative FCF before peak seasons as they build inventory, followed by strong inflows after sales. Comparing year-over-year performance instead of quarter-to-quarter results helps smooth seasonal volatility.
Capital expenditure impact
Large, irregular investments, such as facility upgrades or major technology purchases, can temporarily depress free cash flow. Looking at a single reporting period in isolation may give you a misleading picture.
Separating maintenance CapEx from growth CapEx, or averaging capital spending across multiple periods, provides a clearer view of sustainable cash generation.
Short-term focus
One strong quarter doesn’t mean your cash flow challenges are solved, and one weak quarter doesn’t signal structural decline. Free cash flow should be evaluated across multiple reporting periods.
Running a consistent cash flow analysis helps you distinguish temporary fluctuations from long-term operational trends.
How to improve your free cash flow
Improving free cash flow requires tightening operations, managing working capital deliberately, and timing major investments strategically. Small operational gains can compound into meaningful liquidity improvements.
Reduce operating expenses
Cutting unnecessary costs increases operating cash flow immediately. Review recurring expenses, eliminate redundant tools, renegotiate vendor contracts, and prioritize spending that directly supports revenue or efficiency.
Even modest expense reductions can materially increase free cash flow over time.
Optimize working capital
Working capital management has a direct impact on cash availability. Reduce excess inventory, tighten credit policies, and negotiate improved payment terms with suppliers to extend your payable cycle responsibly.
Evaluate early payment discounts such as 2/10 net 30 only when the return exceeds your cost of capital.
Time capital expenditures strategically
Large capital purchases can temporarily suppress free cash flow. When possible, align major investments with periods of stronger operating cash flow.
Spreading projects across reporting periods can reduce short-term liquidity strain without sacrificing long-term growth.
Accelerate accounts receivable collection
Speeding up collections improves operating cash flow. Invoice promptly, follow up consistently on overdue accounts, and reassess credit terms for slow-paying customers.
Every additional day in receivables reduces cash available for reinvestment or debt repayment.
Automate financial operations
Manual processes slow visibility and increase administrative overhead. Automation improves accuracy, speeds approvals, and gives you real-time insight into spending patterns.
With better visibility, you can identify waste, prevent duplicate subscriptions, and control discretionary spend before it impacts free cash flow.
Improve free cash flow with automated spend controls and real-time visibility
Free cash flow weakens when spend is reactive and visibility comes too late. If you’re reconciling after transactions post instead of controlling spend upfront, cash leaves your business before you can manage it.
Ramp’s accounting automation software helps you control cash flow at the point of purchase. Instead of reviewing expenses weeks later, you set rules that prevent out-of-policy spend before it happens.
Ramp enforces custom spend policies by merchant, category, amount, or department. When employees submit requests, approvals route instantly with full context attached, so you’re not chasing receipts or clarifying charges after month-end.
Here’s how Ramp helps you protect and improve free cash flow:
- Block out-of-policy spend: Prevent unauthorized transactions before they post
- Track spend in real time: Monitor cash outflows across departments and vendors as they happen
- Automate receipt collection: Match receipts to transactions automatically and reduce reconciliation work
- Close books 3x faster: Sync and categorize transactions automatically, freeing 40+ hours per month for higher-value analysis
Try a demo to see how proactive spend controls and real-time visibility can help you strengthen free cash flow.
FAQs
There’s no universal benchmark for a “good” free cash flow ratio. A mature company may target a 10–15% free cash flow margin, while a high-growth company may intentionally run lower or negative FCF while investing in expansion.
What matters most is consistency and alignment with your growth strategy.
No. Profit, or net income, includes non-cash expenses such as depreciation and amortization. Free cash flow measures the cash remaining after operating expenses and capital expenditures.
You can be profitable on paper and still experience cash constraints if investments or receivables absorb liquidity.
Most companies calculate free cash flow quarterly to align with financial reporting. However, monthly tracking gives you earlier insight into trends and helps you respond faster to cash flow pressures.
Yes. This often occurs when a profitable company invests heavily in capital assets or experiences delays in collecting customer payments. If cash tied up in CapEx or receivables exceeds operating inflows, free cash flow will be negative despite positive net income.
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