Free Cash Flow
Topic 22 explores free cash flow (FCF) and how to calculate and use it in the DCF valuation process. FCF is the cash that is available from business operations after tax after meeting all operating needs of the business (excluding financing) and is available to pay posttax interest expense on debt, meet debt principal payment requirements or other nonoperating obligations, or be returned to stockholders in the form of dividends or stock repurchases.1 FCF is the economic value R (introduced in Topic 20) that provides the basis for doing discounted cash flow (DCF) valuations.
- FCF from ongoing operating results is what matters in valuing a business—not net income plus depreciation or cash flow as determined on a generally accepted accounting principles (GAAP) accounting financial statement presentation format.
- FCF is the amount of cash available from the business from ongoing operations:
After payment of:
- All cash operating expenses
- Cash income tax payments reflecting the effect of deducting tax-deductible cash and noncash charges (excluding interest expense on third-party debt) and
After reinvestment for:
- New plant and equipment or other operating asset requirements (for new capacity or to maintain capacity)
- Operating working capital requirements (for growth), but
Before payment for or receipt from:
- Interest expense or income or other nonoperating income items
- Debt reduction payments or proceeds
- Equity redemptions or proceeds