In investing, free cash flow represents the amount of money a company has left after all its bills are paid. Healthy free cash flow is key to keeping a company growing, expanding and thriving. Read on to learn how to calculate free cash flow.
Items you will need
To get started, you'll need a copy of the company's annual report--its Form 10-K. You can find it by doing a web search for the company's name and the phrase "Form 10-K," you can look at the Securities and Exchange Commission's EDGAR database, or you can go to the company's website and look for its "Investor Relations" page. For this example, we'll use Microsoft's 2007 annual report.
In the 10-K, you'll want to search for the section labeled "Financial Statements," then find the cash flow statement. Here's where you'll find the numbers you need to calculate free cash flow. Those numbers are: cash flow from operations and capital expenditures (financing and investing).
Understand that the actual calculation is incredibly simple. Find the cash flow from operations. In the 2007 Microsoft report, it's $17,796 (Technically, that's in millions, but who's counting?). Subtract the capital expenditures from this number. For Microsoft, that's -$24,544 in financing and $6,089 in investing (again in millions). So the math looks like this:$17,796-$24,544+6,089---------------$659.So Microsoft had a negative cash flow of $659 (million) this quarter; it spent $659 million more than it brought in.
Know that negative cash flow isn't always bad. Sometimes a company needs to spend to expand its business, and in Microsoft's case, even though its cash flow was negative in 2007, it nonetheless finished out the year with plenty of money on hand. The cash flow statement also shows that it had $6,714 million in cash and cash equivalents in the bank at the beginning of the year, so even though it spent $659 million more than it made during the year, it still ended up with a healthy $6,055 million to its name. (On the cash flow statement, its cash and equivalents at the end of 2007 actually comes out to $6,111 million due to exchange-rate adjustments.)
Once you're armed with your free cash flow number, it's time to dig a bit deeper into the company to find out the reason behind it. Microsoft spent a lot of money in 2007, but Microsoft has a lot of money--it can spend without breaking the bank. A company that hoards all its money might actually be better served by reinvesting some of that money in the business (or paying a dividend), whereas a company that spends freely might be doing so for one-time reasons that will lead to more profit in the future. Do your homework.