2) Free cash flow (FCF): is the cash flow that a business generates and is available for distribution to debt holders and equity holders. It consists of the cash flow thrown off by operations minus the use of funds from the growth in its net working capital and from its capital expenditures required to maintain the firm's growth. It is commonly approximated by:
free cash flow = EBIT plus depreciation expense minus income taxes
minus the change in net working capital minus capital expenditures
This definition has the advantage that an external analysts can find the data on published financial statements. However, it has two disadvantages:
- It does not adjust for other accruals which may be distorting EBIT.
- The proper measure of FCF would use the required growth in net working capital and the required capital expenditures not the actual amounts. These requirements, of course, are not published. An analyst might estimate the firm's growth requirements and substitute his own estimates for the published actuals.