Bill Hanna explains free cash flow as operating cash flow minus capital expenditures. A company with $2 million in operating cash flow and $1.6 million in CapEx has $400k in free cash flow to reinvest, pay dividends, or return to shareholders.
What is free cash flow? Free cash flow is what's left over after the operating cash flow and reducing that by your capital expenditure. So if you have a cash balance at the beginning of the period here, cash balance goes down, you pay rent, it goes up as you collect from customers, it goes down again as you make payroll, up again with collection, down with inventory. At the end of that, that is the net change is operating Cash flow. After that, the business invests in CapEx, buying equipment to run the business, and the net effect of all of these is what we call free cash flow. So to give you an example, if a company has operating cash flow of $2 million and a capital expenditure of $1.6 million, free cash flow would be taking the $2 million minus $1.6 million CapEx. The leftover is $400K, which is— can be used as free cash flow and reinvesting in the business for long-term growth, paying shareholders in terms of dividends, things that the company can do with that money to grow the business and the shareholder value. So $400K is the free cash flow in this case, even though operating cash flow is $2 million, free cash flow is $400K. To get more Finance Bytes, go ahead and follow the channel.
