What is free cash flow? It is the cash that a company accumulates after costs and revenue are deducted. Free cash flow (FCF) is a measurement of how much money a company actually generates after deducting expenses for property, equipment or building. This cash is available to the management for usage in the operation and growth of the business.
The first step in understanding what is free cash flow is to determine the value of all capital assets, including retained earnings. These include earned revenues and the cost of doing business. The total cost of doing business is determined by subtracting the cost of goods sold from gross receipts received. Profits are reported on the statement of earnings. All assets with a fair market value are included in the enterprise value.
Net cash collections refer to the amount of cash that is still required to pay expenses and settle the outstanding balance as well as pay tax. Net cash collections are calculated by adding the gross selling price of products, less cost of good sold, less distributor freight cost, less selling and administrative expenses, less bank fees, less debt and equity. Net cash collections are usually positive. A company can lose net cash if it overspends on purchase items, pays too many taxes, and pays too many bills. On the other hand, a company can have positive net cash if it purchases fewer goods and sells less items, pays more taxes, and pays less in interest and other debt obligations. Net cash flow is an indication of a company’s ability to fund its activities and meets cash needs.
Present value is a method of determining what is free cash flow by comparing the present value of expected cash inflows over the period of interest and other debt payments. The present value of future payments is defined as the amount of money that a lender will be able to collect from a borrower at a given point in time. Present value is usually expressed as a percentage rate over a period of time. This percentage rate is most often, but not always, derived from current market interest rates. The methods of calculation vary greatly among individual companies and institutions. Present value should be used in a financial statement analysis only when the interest-only method or discounted long term loan method is being used.
Net operating activities refer to the total number of completed transactions and the total amount of cash used or funds available to operate the business. The information reported under this column is generally summarized for the year-end at the end of the reporting period. This summary reflects current and historical operating balances and includes the following: cash paid in payroll, capital expenditures, accrued expenses, inventory, gross value of property, accounts receivable, short-term financing, and reserve fund. An operating cash flow statement is not presented if the business is experiencing a net loss for any one or more of its non-revenue producing activities. A profit and loss statement is required to determine the income of the enterprise. A cash combination statement is also included to provide balance sheets with a description of the sources of profit and loss.
The first step in what is free cash flow (fcf) calculation is to determine the net change in the total of total revenue and expenses over the reporting period. Expenses consist of the direct costs of production such as the cost of raw materials, labor, and advertising. Direct costs are those types of expenses that are incurred before customers buy products. Net revenue on the other hand, refers to the sales of products and the value of services sold to customers during the reporting period.
Net income is the income from operating the business without regard to the effect of one or more of the indirect costs mentioned earlier. Net income can be determined by different methods. One method is to add the total gross revenue and expenses, less the operating capital. Another method is to subtract the gross revenue and expenses, less the operating capital statement. Both methods result in net income.
There are many other methods to calculate free cash flow (faf) including specific rate of interest, depreciation, and amortization. All these factors have effects on the net income statement. Other factors that affect the faf calculation are current and long term financing needs, ability to pay tax and legal obligations. When a company requires financing, the operating statement must be prepared. Such reports prepare and explain financial information used to make the capital expenditure decisions.