Free cash flow, explained simply
What free cash flow is, how it differs from profit, and why investors watch it.
The idea
Free cash flow is the cash a business generates from its operations after paying for the equipment, buildings and software it needs to keep running and growing. In its simplest form it is operating cash flow minus capital spending.
It is the money that is genuinely available for paying down debt, paying dividends, buying back shares or investing in something new.
Why it can differ from profit
Profit follows accounting rules: revenue is counted when it is earned and costs are spread over time. Cash is counted when it moves. A company can report a profit while customers have not paid yet, or while it is spending heavily on new factories.
Neither number is “the truth” on its own. When profit and free cash flow tell the same story over several years, that is reassuring. When they diverge for a long time, the filings usually explain why, and it is worth reading.
Reading it well
Look at several years, not one. A single weak year may simply be a big investment. Compare free cash flow with revenue (the free cash flow margin) to compare companies of different sizes, and remember that capital-heavy industries such as utilities and telecoms naturally run lower margins than software companies.