Concept of Free Cash Flow
An important derivative tool for analyzing cash flows is the free cash flow calculus. Free cash flow means the amount available for corporate purposes after provisions for financing outlays and expenditures to maintain productive capacity at current levels. This concept is helpful in assessing the internal growth and financial flexibility of the organization. It indicates the ability of the firm to meet ongoing financial and operational commitments and above it, its ability to finance growth.
Generally free cash flows are calculated as follows:
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Particulars
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Amount
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Cash from Operations
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xxx
|
|
Less: Capital expenditure required to maintain productive capacity used up in the production of income
Dividends
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xxx
xxx
|
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Free Cash Flow
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xxx
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Positive free cash flows reflect the availability of amount for business activities after allowance for financing and investing requirements in order to maintain productive capacity at current level. One thing to be noted here is - the companies does not disclose the capital expenditure needed to maintain productive capacity at current levels.
Free cash flows, in other words, are nothing but the amount available for maintenance of the organization. If free cash flow is increasing, it means there is a reduction in the investment activities and this results in slow growth. If free cash flow is decreasing, it indicates the investment is being used for productive purpose. Generally, the trend of this cash flow depends upon the management's future plans.
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