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What is Free Cash Flow, How to anylaze free Cash Flow of a company ?

Free cash flow is one of the most important topics to evaluate a company, many of you are involved in the fundamental analysis of a company, then you must have heard of this word. However, those people who are unfamiliar with the term free cash flow, this is a mystery for them.

In this post, we will discuss a wide range of free cash flows and will try to know why it is important to evaluate when researching the company.

Let's try to understand this with the help of the following point. This post of mine is also important for those who want to learn to evaluate the stock.

1. What is Free Cash Flow (FCF) ?

Free cash flow is cash which is available to all the investors of the company. It represents the additional cash that a company is capable of generating the necessary funds for its operation or after expanding its asset base.

Here you need to understand that not all income is equal to cash. If a company is earning, it does not mean that it can spend all the income directly. The company can only spend free cash. There is a significant difference between 'cash' and that cash, which can be taken out of a business', or in accounting words: Cash from operating activities and free cash flow (FCF).

The cash received from operating activities is the amount of cash generated by the business operation of a company. However, all cash can not be excluded from the business because of operational activities, because the company is required to keep current. These expenses are called capital expenditure (CAPEX).

On the other hand, free cash flow is the cash that the company can generate after spending the necessary money to stay in the business. It is cash at the end of the year, after deduction of all operating expenses, expenditure, investment etc. and available to all stakeholders of any company (both stakeholders including equity and debt investor).

2. Why is free cash flow is important ?

It is important for investors to see the free cash flow of a company because it is relatively accurate method in finding its profitability compared to the company's earnings.

This is because the earnings reflect the current profitability of the company. On the other hand, free cash flow indicates the future development prospects of the company as it is a cash which allows the company to pursue the opportunities to increase the shareholder's value. Free cash flow shows the ease with which businesses can grow or pay dividends to the shareholder.

Extra cash can be used to expand its portfolio, developing new products, making useful acquisitions, paying dividends, reducing debt or pursuing any other 
development opportunity.

In addition, free cash flow is also used as input by calculating the value of a company using the popular valuation technique- Disconnected Cash Flow (DCF) model.

3. How to analyzed free cash flow of a company ?

When it is studying the company's free cash flow, it is important to find that where the cash is coming from. Cash can be generated either from earnings or debt. While increasing cash flow due to increase in earnings is a good sign. However, this is not the same with debt.

Apart from this, if two companies have only one free cash flow, it does not mean that they have the same probability of future. Some industries have capital expenditure more than other industries. In addition, if the CAPEX is high, then you need to check that the reason for high capital expenditure is due to expenditure or expenditure in development. To learn them, you have to carefully read the quarterly / annual reports of companies.

4. Negative cash flow ?

For investors, the continuous decreasing or negative free cash flow can be a warning signal. Negative free cash flow is dangerous because it can slow down business. In addition, if the company did not improve its free cash flow, then he may have to face insufficient liquidity to stay in business.

5. Conclusion.

In this post, we discussed the Free Cash Flow (FCF). This is a scale of financial performance of the company. The free cash flow indicates how much cash a company has left from its operations, i.e. the cash used to carry forward the opportunity to improve shareholder value.

That's all I hope for this post that it was helpful for you. Happy investment.
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Comments

  1. Simran Shah31 December 2018 at 01:36

    Really got a useful blog to which shows the proper market update. Its very informative, keep posting more like this.
    Intraday stock tips

    ReplyDelete
  2. Ashish Solankee1 January 2019 at 03:48

    Thanks, to get the latest updated post make sure you subscribe email newsletter.

    ReplyDelete

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