Free Cash Flow
Cash generated after paying operating expenses and capital expenditures \u2014 the money the business actually produces. Unlike earnings, it's difficult to fake with accounting. Free cash flow is what funds dividends, buybacks, debt repayment, and reinvestment. The best measure of a business's economic engine.
Why it matters
Warren Buffett's preferred metric. Note: Buffett's coined metric "owner earnings" differs from standard FCF by excluding growth capex \u2014 only subtracting maintenance capex. FCF is harder to manipulate than earnings because cash either exists or it doesn't. It's the pool of cash available for dividends, buybacks, debt repayment, or acquisitions.
How to read it
FCF should broadly track net income over time. If net income is consistently much higher than FCF, the company may be capitalizing expenses aggressively (accounting red flag). Negative FCF isn't necessarily bad for high-growth companies investing heavily, but it should eventually turn positive.
Source
Jensen, Michael (1986). "Agency Costs of Free Cash Flow." American Economic Review.
Lessons that use this term
- Cash Flow: Follow the Money
- EBITDA: What It Is and Isn't
- The Cash Flow Walk: What Each Section Is Telling You
- Stock-Based Compensation: The Non-Cash Expense That Dilutes
- DCF: What Is a Company Really Worth?
- Earnings Quality: Why Coca-Cola Trades at a Premium
- Earnings Predictability
- From Economics to Stock Analysis
Related terms
Ambiguity Aversion · Anchored Assumption · Asset Beta · Bank ROE Spread · Banker Pitch Deck · Beta
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