"Cash flow" and "free cash flow" are financial metrics to determine a company's liquidity. However, there are distinct differences between the two that allowinvestors to see how a company generates cash and how it spends it.
Key Takeaways
- "Cash flow" and "free cash flow" are financial metrics that help determine a company's liquidity.
- Positive cash flow indicates that a company's liquid assets are increasing.
- Free cash flow is the remaining cash after a company has paidits operating expensesand capital expenditures.
Cash Flow
Cash flowis the net amount of cash and cash equivalents transferred into and out of a company.Positive cash flow indicates that a company's liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, and pay expenses.
Cash flow is reported on thecash flow statement, which contains three sections detailing operating, investing, andfinancing activities.
Free Cash Flow
Free cash flow (FCF) is the cash a companyproduces through its operations after subtractingany outlays for investment in fixed assets like property, plant, and equipment. In other words, free cash flow orFCF is the cash left over after a company has paidits operating expensesand capital expenditures.
Free cash flow is a company's ability to generate cash above its operating and investing needs. Free cash flow reveals whether a company has enough, after funding operations and capital expenditures, to pay its creditors and equity investors through debt repayments, dividends,andshare buybacks.
To calculate FCF, subtract capital expenditures from cash flow from operations.
Comparing Cash Flow to Free Cash Flow
Below isan example of the quarterly cash flow statement for Exxon Mobil Corporation (XOM) for the first quarter of 2018. Totalcash flow was less than freecash flow partly because of reductions in the short-term debt of $3.872 billion, listed under the financing activities section. Cash outlays for dividends totaling $5.742 billion also reduced the total cash flow for the company.
Cash Flow
- Exxon had $4.125 billion in cash flow for the quarter (in green at the bottom of the statement).
- The total cash flow includes the net amount of debits and credits forcash activities in all three sections of the statement (operating, investing, and financing).
Free Cash Flow
- Exxon had $8.519 billion in operating cash flow (in blue).
- The company also invested in a new plant and equipment, purchasing $3.349 billion in assets (in red). The purchase is a cash outlay.
- The free cash flow for Exxon was $5.17 billion for the period ($8.519 billion minus $3.349 billion).
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Why Is It Important to Compare Cash Flow to Free Cash Flow?
By comparing cash flow to free cash flow, investors can gain a better understanding of where cash is coming from and how the company is spendingits cash. For example, a company may be holding cash that appears to be a positive sign of financial health. However, under closer inspection,investors may uncoverthat the company has takenon a sizable amountof debt and does not have the cash flow to support it.
What Do the Metrics Tell Investors?
Using cash flow figures, investors can see how much a companygeneratesfrom its normaloperations, what they're investing in, and how much debt they'repaying down or taking on. As a result, investors canmake a moreinformed decision as to the financial viability of the company and its ability to pay dividends or repurchase shares in the upcoming quarters.
What Is a Company's Liquidity Important?
Liquidity measures the ease with which a company can meet financial obligations with the liquid assets available and the ability to pay off debts as they come due.
The Bottom Line
"Cash flow" and "free cash flow" help reveal a company's liquidity. Liquidity is the ease with which a company can meet its financial obligations. Investors can use these metrics to see how much a companygenerates, what they're investing in, and how much debt they hold.
