What it is
Free cash flow (FCF) is the cash a company has left after running the business and paying for the equipment, buildings and software it needs to keep going and grow.
Free cash flow = cash from operations - capital expenditure (capex)
Both numbers are on the The cash flow statement.
Why it matters
Earnings include accounting choices: when revenue is recognised, how fast assets are depreciated, one-off charges. Cash is harder to fake. A company reporting growing profits but little or no free cash flow deserves a closer look.
Free cash flow is what a company can use to:
- pay down debt,
- buy back shares or pay dividends,
- acquire other businesses,
- build up cash for hard times.
Useful ratios
| Ratio | Formula | Use |
|---|---|---|
| FCF yield | FCF / market cap | Cash return on the price you pay; compare with bond yields |
| FCF margin | FCF / revenue | How much of each sales dollar becomes spare cash |
| Net debt / FCF | (debt - cash) / FCF | Years needed to pay off debt; under 3 is comfortable |
When FCF and earnings differ
- FCF well below earnings: heavy investment (fine if growth follows), customers paying slowly, or aggressive accounting.
- FCF well above earnings: large non-cash charges such as depreciation or stock-based compensation, or customers paying upfront (common in subscriptions).
Stock-based compensation is added back in operating cash flow, which flatters FCF. For software companies, subtract it to see the owner's real cash.
Caveats
- Capex is lumpy; look at several years.
- Young, fast-growing companies often have negative FCF on purpose. Check the cash runway.
See also
- The cash flow statement How to read the cash flow statement's three sections, operating, investing and financing, and why cash flow can reveal what earnings hide.
- Balance sheet strength: cash versus debt Why cash above debt is the simplest safety test for a company, how to judge debt with free cash flow, and what cash buys in hard times.
- Net margin Net profit margin shows how much of each sales dollar a company keeps after every cost. What counts as strong, and how to read its trend.
- Return on invested capital (ROIC) ROIC shows how much profit a company earns on the money invested in it. Why it is the best single test of a moat, and how it compares with ROE.
Pages that link here: Building your investing knowledge, Debt-to-equity ratio, EV/EBITDA, Fundamentals checklist, Growth, value and dividend investing, How to read financial statements, How to research a company, P/E ratio (price-to-earnings)
Last updated September 30, 2026. Education only, not investment advice.