Free cash flow

Operating cash flow minus the capital spending needed to keep the business running and growing. It is what is genuinely available to pay lenders and owners, and it is the quantity a discounted cash flow model discounts.

The manufacturer generating ₹785 crore from operations and spending ₹460 crore on plant has ₹325 crore of free cash flow.

Definitions differ, and the differences are not trivial. Free cash flow to the firm is measured before interest, so it belongs to lenders and owners together and is discounted at the weighted average cost of capital. Free cash flow to equity is measured after interest and after debt movements, so it belongs to shareholders alone and is discounted at the cost of equity. Mixing the two, by discounting a pre-interest cash flow at the cost of equity, is the commonest error in an amateur valuation, and it produces an answer that is wrong by roughly the size of the debt.

Say which one you built.

Cash after the spending that keeps it alive.

Cash after the spending that keeps it alive.

One year of the figure is close to useless and this is where most beginners go wrong. Capital spending is lumpy: a company that commissioned a plant last year and is building nothing this year will show free cash flow that looks transformational and is nothing of the sort. Average across a full investment cycle, or normalise capital expenditure to the level the business needs to hold its position, and the number becomes comparable. A five-year average of free cash flow against a five-year average of net profit is one of the most informative two-number comparisons available.