• The Free Cash Flow Formula
  • Where the Two Numbers Come From

Free cash flow is the cash a business generated from its operations in a period, minus what it spent on long-term assets such as equipment and buildings in that period. You take both numbers from the cash flow statement: net cash from operating activities, less capital expenditures.

The Free Cash Flow Formula

OpenStax's Principles of Accounting (§16.2) puts it this way: "Free cash flow is calculated as cash flow from operating activities, reduced by capital expenditures, the value for which is normally obtained from the investing section of the statement of cash flows."

Free cash flow = net cash from operating activities − capital expenditures

Where the Two Numbers Come From

The same OpenStax section describes the parts of the cash flow statement you need:

  • Operating activities: operating cash flows "arise from the activities a business uses to produce net income". This is where cash collected from customers shows up.
  • Investing activities: "cash business transactions related to a business' investments in long-term assets", including "payments for the purchase of land, buildings, equipment". Your capital expenditures come from this section.
  • Financing activities: "cash transactions related to the business raising money from debt or stock, or repaying that debt". Loan repayments sit here, so the formula doesn't subtract them.

To build the operating figure from net income step by step, see the worked example in what is a cash flow statement.

Worked Example: A Landscaping Business's Year

This is a sample with invented figures. A landscaping business's cash flow statement for its year shows:

  • Net cash from operating activities: $86,000.00
  • Investing section: purchase of a mower and trailer, $31,500.00
  • Financing section: loan principal repaid, $18,000.00

Step 1: find capital expenditures. The equipment purchase in the investing section is the capital expenditure: $31,500.00.

Step 2: calculate free cash flow. $86,000.00 − $31,500.00 = $54,500.00.

Step 3: account for required payments the formula leaves out. The $18,000.00 of loan principal is a financing outflow, so it isn't in free cash flow. After it, $54,500.00 − $18,000.00 = $36,500.00 remains.

So the business generated $54,500.00 of free cash flow, but $18,000.00 of that was already committed to the loan.

What the SEC Says About the Term

For companies that file with the US Securities and Exchange Commission, SEC staff guidance (Question 102.07, May 17, 2016) says free cash flow "does not have a uniform definition and its title does not describe how it is calculated." It adds that "free cash flow" should not be used in a way that "inappropriately implies that the measure represents the residual cash flow available for discretionary expenditures", because required debt payments and other required spending aren't deducted from it.

If your business doesn't file with the SEC, the same points apply when you share the figure with a lender or buyer: say how you calculated it, and don't present it as cash that's free to spend. Ask your accountant which adjustments fit your business.

Free Cash Flow and Getting Paid in Billed

Cash collected from customers is part of operating cash flow. In Billed, you "Set a due date on each invoice so your client knows when to pay", and invoice reports show "which invoices are paid, partially paid or past due". You can "see who owes you money and send them a payment reminder", according to Billed's invoice software page.

Billed's financial reporting page says: "Billed offers several built-in reports: Invoice Reports (paid, partially paid, and overdue), Expense Reports, Income vs Expense Reports, Top Selling Products, and Time Tracking Reports." That list doesn't name a cash flow statement, so take the two figures for free cash flow from a cash flow statement prepared separately.

Related Guides

FAQ

How do you calculate free cash flow?

Take net cash from operating activities on the cash flow statement and subtract capital expenditures, which come from the investing section. In the worked example above, $86,000.00 minus $31,500.00 gives free cash flow of $54,500.00.

Is free cash flow the same as operating cash flow?

No. Operating cash flow is the cash a business generates from the activities it uses to produce net income. Free cash flow is that figure after capital expenditures have been subtracted.

Can free cash flow be negative?

Yes. If capital expenditures in a period are larger than net cash from operating activities, free cash flow for that period is negative.

Does free cash flow include loan repayments?

No. Repaying loan principal is a financing activity, and the free cash flow formula subtracts only capital expenditures. SEC staff guidance warns against presenting free cash flow as cash available for discretionary spending, because required debt payments aren't deducted from it.

Is there one official definition of free cash flow?

No. SEC staff guidance (Question 102.07, May 17, 2016) says this measure "does not have a uniform definition and its title does not describe how it is calculated", and that "a clear description of how this measure is calculated, as well as the necessary reconciliation, should accompany the measure where it is used."

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