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What is the Free Cash Flow Calculation?

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Question: What is the Free Cash Flow Calculation?

The question is what is the free cash flow calculation? There are actually several ways to calculate free cash flow that come up with the same answer if calculated correctly.

Answer:

There are three ways to do the free cash flow calculation. Free cash flow is defined as the cash flow available to all the company's investors, including shareholders and bondholders, after the company has made all investments necessary to sustain its ongoing operations.

The first free cash flow calculation is:

Free Cash Flow = Sales Revenues - Operating Costs and Taxes - Required Investments in Operating Capital where:

Sales revenues are taken from the income statement. Operating costs and taxes are also taken from the income statement. Investments in new operating capital show up as increases in fixed assets on the balance sheet.

The second free cash flow calculation is:

Free Cash Flow = Net Operating Profit After Taxes (NOPAT) - Net investment in operating capital

where NOPAT is the same figure [Sales Revenue - Operating Costs and Taxes] as in the first free cash flow calculation and net investment in operating capital is the same as the third term in the first calculation or the increase in fixed assets on the balance sheet.

The third free cash flow calculation is:

Free Cash Flow = Net Cash Flow From Operations - Capital Expenditures

where Net Cash Flow From Operations comes from the first section of the Statement of Cash Flows and Capital Expenditures comes from the increase in fixed assets off the balance sheet.

All three methods of calculating free cash flow should yield the same answer as they just approach the same information from different angles.

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