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What Is Free Cash Flow (FCF)? Formula, Yield and Example
Free cash flow is the cash a company has left after running and maintaining its business. Learn the FCF formula, FCF yield and why it beats profit alone.
Free cash flow in 60 seconds
- Free cash flow (FCF) is the cash left after a company pays for operations and the investment needed to keep and grow the business.
- Formula: cash flow from operations − capital expenditure.
- Profit can be shaped by accounting; cash is harder to fake — steady positive FCF is a sign of a healthy business.
Educational summary — not investment advice.
Profit is an accounting figure. Free cash flow is what actually remains in the bank after the company has paid to run the business and to replace and expand its machinery, plants and other assets.
That leftover cash is what can be used to pay dividends, buy back shares, reduce debt or make acquisitions — which is why many investors treat FCF as the truest measure of what a business earns for its owners.
How is Free cash flow calculated?
| Measure | Formula |
|---|---|
| Free cash flow | Cash flow from operations − Capital expenditure (capex) |
| FCF yield | Free cash flow ÷ Market capitalisation × 100 |
| FCF conversion | Free cash flow ÷ Net profit × 100 |
Both inputs come from the cash flow statement: 'cash flow from operating activities' and the purchase of fixed assets (capex) shown under investing activities.
Free cash flow example with numbers
| Item | Value |
|---|---|
| Cash flow from operations | ₹400 crore |
| Capital expenditure | ₹150 crore |
| Free cash flow | ₹250 crore |
| Market capitalisation | ₹5,000 crore |
| FCF yield | 5.0% |
After spending ₹150 crore on assets, the company generated ₹250 crore of free cash. Against a ₹5,000 crore market value, that is an FCF yield of 5.0% — the cash return an owner would get if all of it were paid out.
Example Ltd — illustrative figures.
Why FCF matters more than profit
- A profitable company can still run out of cash if customers pay late, inventory piles up or capex is heavy.
- Consistently strong FCF funds dividends and buybacks without borrowing.
- FCF that trails profit year after year is a red flag about earnings quality.
Reading FCF sensibly
Negative FCF is not always bad — a fast-growing company investing heavily in new capacity may deliberately spend more than it earns for a few years. What matters is whether that investment earns good returns later. Look at several years of FCF, not one, and compare it with net profit and debt.
The cash that is truly free
A company's profit is an accounting result: sales minus expenses, with rules about when each is recognised. Cash is what actually arrives in the bank account. The two often diverge, and the reasons why are among the most useful things an investor can learn.
Free cash flow starts with the cash the business generates from operations and subtracts the money it must spend to maintain and expand its physical capacity. What is left is genuinely free: it can pay dividends, buy back shares, reduce debt or be kept for a rainy day. A company that reports rising profits but never produces free cash is, in effect, spending everything it earns just to stand still.
Finding the numbers in a cash flow statement
Indian listed companies file a cash flow statement with their annual and half-yearly results on NSE and BSE. Two lines give you free cash flow:
- Net cash flow from operating activities: cash generated from the core business after tax.
- Purchase of property, plant and equipment and intangibles (including capital work in progress), found under investing activities. This is capital expenditure, or capex.
Free cash flow is the first minus the second. A company reporting operating cash flow of ₹500 crore and capex of ₹300 crore has free cash flow of ₹200 crore. Some analysts also separate capex into maintenance capex — needed to keep existing capacity running — and growth capex for new capacity. If ₹100 crore of the ₹300 crore is maintenance, the cash the existing business really throws off is 500 − 100 = ₹400 crore.
Why profit and cash differ: a bridge
Suppose a company reports a net profit of ₹400 crore. Here is how that can become a much smaller operating cash flow:
| Step | Amount |
|---|---|
| Net profit | 400 |
| + Depreciation and amortisation (non-cash charge) | +120 |
| − Increase in receivables (customers paid later) | −150 |
| − Increase in inventory | −60 |
| + Increase in payables (suppliers paid later) | +40 |
| Operating cash flow | 350 |
With capex of ₹200 crore, free cash flow is ₹150 crore: only 37.5% of the ₹400 crore profit. The gap is receivables and inventory building up. Occasionally that is healthy growth; if it happens year after year it can mean customers are slow to pay, stock is not selling, or sales are being pulled forward. A persistent gap between profit and free cash flow is one of the best early warnings of trouble.
Free cash flow yield and conversion
- FCF yield = free cash flow ÷ market capitalisation. It is what you would earn in cash if you bought the whole company at today's value. A ₹200 crore free cash flow on a ₹4,000 crore market cap is a 5% yield.
- FCF conversion = free cash flow ÷ net profit. Consistently strong conversion (near or above 70–80% for mature businesses) shows profits are real.
- Cash return on capital: compare FCF with the capital invested, to see how much cash the business earns on its assets.
Compare the FCF yield with what safe alternatives pay. If a risk-free government bond yields 7% and a stock's FCF yield is 3%, the stock must be growing quickly to justify its price.
Negative free cash flow is not always bad
A company building a new plant will spend heavily now and earn later, so negative free cash flow in a growth phase can be perfectly rational. The question is whether the investment earns more than it costs. A company with negative FCF this year, a rising ROCE and new capacity coming on stream is in a different position from one with negative FCF, falling margins and rising debt.
Sectors to watch include power, infrastructure, telecom and metals, where large expansions can push free cash flow negative for years. Look at a five-year total rather than a single year, and check whether the borrowing that funds the spending is manageable.
Test yourself
- Question 1. Operating cash flow ₹220 crore, capex ₹90 crore. FCF? Answer: ₹130 crore.
- Question 2. Market cap ₹2,600 crore. FCF yield? Answer: 130 ÷ 2,600 = 5%.
- Question 3. Net profit ₹260 crore. FCF conversion? Answer: 130 ÷ 260 = 50%.
- Question 4. Receivables jump by ₹80 crore while profit is unchanged. What happens to operating cash flow? Answer: it falls by about ₹80 crore.
Free cash flow completes the picture that EBITDA starts, and it is the base for judging whether a dividend is safe.
On NSE and BSE: what to keep in mind
- Capex-heavy Indian sectors — power, infrastructure, telecom, metals — can show negative free cash flow during an expansion. Judge whether the new capacity earns more than the cost of the debt used to build it.
- The cash flow statement is generally filed with the half-yearly and annual results on NSE and BSE, so free cash flow is usually a half-yearly or annual number in India.
- Compare free cash flow with net profit over several years: profit that keeps failing to become cash is a red flag.
Free cash flow: frequently asked questions
Is free cash flow the same as profit?
No. Profit follows accounting rules and includes non-cash items; free cash flow tracks the actual cash after necessary investment.
What is a good FCF yield?
A higher FCF yield means you pay less per rupee of free cash, but it must be sustainable. Compare it with sector peers and with interest rates.
Can a company have profit but negative FCF?
Yes — heavy capex, growing working capital or slow customer collections can all drain cash even in a profitable year.
Disclaimer: this article is for education only. The figures in the worked example are illustrative and do not describe any real company listed on NSE or BSE. It is not investment advice, and investingg.in is not a SEBI-registered advisor.
The bottom line
Free cash flow is the cash a business truly earns for its owners. Companies that turn profit into steady free cash flow are the ones that can pay dividends, cut debt and keep growing.
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Disclaimer: This analysis is for educational purposes only and should not be considered investment or trading advice. Please consult your financial advisor before making investment decisions.