The simplest definition of free cash flow is the cash inflow remaining after paying for current operations and investments into the growth of the company.
This is the amount of profit that is passed to shareholders of a company.In financial analysis, many consider expected free cash flow to be the basis of corporate valuation.It is important to understand how free cash flow differs from net income.
Net income is the final line of an income statement. It is important to realize, though, that the income statement is an economic perspective on the business’ results for a given period.Payments and receipts are ignored, and replaced by sales and expenses related to those sales.
Additionally, capital purchases are replaced by depreciation. On the income statement, these changes are made to smooth results, so that period-to-period comparisons can be made more easily.
Yet, at the end of the day, a business is all about free cash flow. This is the amount of money that the business is generating.
Some companies with very strong income statements generate significantly less free cash flow.Contrarily, some businesses have lower profits on their income statements but generate higher levels of cash flow. Understanding your business’ free cash flow will allow you to improve cash flow management, and to estimate the financial value of your company.
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