Free Cash Flow (FCF) measures how much cash is available for the company’s discretionary use.
FCF = Net Income + depreciation + amortization + deferred taxes - dividends - debt repayments - capital spending - changes in inventories - change in net receivables.
If the company has a significant amount of FCF they should be able to invest it to gain higher returns in future. Else, if it does not have FCF then it’s interest payments will have to increase as a result of needing to borrow additional funds.
Calculation of Free Cash Flow Method 1 Net sales - Cost of goods sold (COGS) - Selling, general & admin (SG&A) EBIT - Adjusted taxes NOPLAT +Depreciation - Capital expenditures - Working capital needs Free Cash Flow Method 2 Net income +Depreciation +After-tax net interest expense - Capital expenditures - Working capital needs Free Cash Flow