Free Cash Flow

This chapter explores free cash flow (FCF) and how to calculate and use it in the DCF valuation process. FCF is the cash that is available from business operations after tax after meeting all operating needs of the business (excluding financing) and is available to pay post-tax interest expense on debt, meet debt principal payment requirements or other non-operating obligations, or be returned to stockholders in the form of dividends or stock repurchases. FCF can be determined in a straightforward manner on an “earnings before interest, tax, depreciation, and amortization (EBITDA)” basis or earnings before interest and tax (EBIT) basis. All recurring operating charges and income related to the core business are included in EBITDA and EBIT. All non-operating charges and income are excluded. Inventory and cost of sales are stated on a first-in, first-out (FIFO) inventory basis. The cash effect of (material) net operating loss carry-forwards or carry-backs (NOL) utilization is excluded from the projected cash tax expense.