Free cash flow is operating cash flow minus capital expenditures. It measures the cash a company has left after paying to run the business and maintain or grow its asset base — the money actually available to the people who financed it. You need it whenever a problem asks what a firm could pay out, pay down, or reinvest, and it is the number a DCF valuation discounts.
FCF = Operating cash flow − Capital expenditures
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Both inputs sit on the statement of cash flows, so you never build them from scratch.
Operating cash flow is the last line of the operating section. Most companies build that section with the indirect method — starting from net income and adjusting for non-cash items and working capital changes. How the section itself is assembled is covered in the statement of cash flows; for the FCF formula you only need its final number, usually labeled "net cash provided by operating activities."
Capital expenditures sit in the investing section. Take the line usually labeled "purchases of property, plant, and equipment," not the investing section total — that total also mixes in acquisitions and marketable-securities trades, which are not CapEx.
When an exam or a valuation says "free cash flow" without qualifying it, check which of two variants it means. FCFF (free cash flow to the firm) is unlevered: the cash available to everyone who financed the company — lenders and shareholders alike — measured before any debt payments. FCFE (free cash flow to equity) is levered: the cash left for shareholders only, after interest and after borrowing or repaying debt. In a DCF, FCFF is discounted at the weighted average cost of capital, and the forecast usually ends with a terminal value built on the final year's free cash flow.
Starting from operating cash flow, the two variants are one adjustment apart.
FCFF = OCF + Interest expense × (1 − Tax rate) − CapEx
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FCFE = OCF − CapEx + Net borrowing
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If a problem gives you no debt at all, the three formulas collapse into the same number: with zero interest and zero borrowing, FCF, FCFF, and FCFE are identical.
Marlowe Outdoor Supply reports the following lines in year one. The first four rows are the operating section of its cash flow statement; the fifth comes from the investing section.
| Line | Amount | Where it sits |
|---|---|---|
| Net income | $41,200 | Top of the operating section |
| + Depreciation and amortization | +$18,700 | Operating section, non-cash add-back |
| − Increase in working capital | −$6,300 | Operating section |
| = Operating cash flow | $53,600 | Bottom of the operating section |
| − Capital expenditures | −$22,900 | Investing section |
| = Free cash flow | $30,700 |
Marlowe generated $53,600 of cash from operations, spent $22,900 keeping and adding equipment, and kept $30,700 of free cash flow.
In year two, Marlowe builds a new warehouse. The business itself improves — operating cash flow rises — but capital spending jumps.
| Line | Year 1 | Year 2 |
|---|---|---|
| Operating cash flow | $53,600 | $58,100 |
| Capital expenditures | $22,900 | $71,400 |
| Free cash flow | $30,700 | −$13,300 |
Nothing went wrong at Marlowe. Operating cash flow grew from $53,600 to $58,100; the negative free cash flow is a decision, not a symptom. This is the difference between maintenance CapEx — replacing what wears out, roughly the scale of the $18,700 depreciation charge — and growth CapEx, the warehouse spending that should produce higher operating cash flow in later years. The formula cannot tell the two apart; a single year of FCF is honest about how much cash left the building and silent about why. When CapEx is lumpy, look at free cash flow over three to five years before judging it.
In year one, Marlowe earned $41,200 of net income but produced only $30,700 of free cash flow. The two numbers diverge for three reasons, and each one is visible in the table above.
First, non-cash charges. Depreciation of $18,700 reduced net income, but no cash left the company for it this year — so it gets added back on the way to operating cash flow.
Second, working capital. Marlowe put $6,300 of cash into inventory and receivables. That is real cash out the door, but it is not an expense, so net income never saw it.
Third, CapEx. The $22,900 of equipment purchases left the bank account in full, yet the income statement only ever shows the depreciation slice of that spending, spread over years.
Year two makes the gap dramatic. Marlowe's net income stays positive at $44,800, while free cash flow is −$13,300 — because the $71,400 warehouse never appears as a year-two expense. Net income answers "what did the firm earn under accrual rules?" Free cash flow answers "what cash is actually left for investors?" They are different questions, so they give different numbers.
The most common error is treating one CapEx-heavy year as the trend. FCF is lumpy by nature: a firm that spends $71,400 on a warehouse this year will not do so every year. Average CapEx over several periods, or separate maintenance from growth spending, before concluding anything about the business.
The second error is mixing the variants. FCFF pairs with the WACC and values the whole firm; FCFE pairs with the cost of equity and values only the shareholders' claim. Discounting FCFF at the cost of equity — or adding back interest when you are already using FCFE — double-counts the debt and produces a wrong valuation, not just a messy one.
The third is reading negative FCF as failure. A growth-stage company that pours cash into new stores or servers can post negative free cash flow for years while getting more valuable, exactly like Marlowe in year two. The question is whether the operating cash flow that CapEx buys eventually shows up — not whether this year's FCF is positive.
Free cash flow is operating cash flow minus capital expenditures — the cash left for investors after the firm pays to maintain and grow its assets. Before you compute anything, check which variant the problem wants: FCFF is before debt (unlevered, discounted at WACC), FCFE is after debt (levered, discounted at the cost of equity).
It is the cash a company has left after running the business and paying for the equipment and buildings it needs. Formally: operating cash flow minus capital expenditures. That leftover cash is what could go to lenders and shareholders.
Take the last line of the operating section (net cash provided by operating activities) and subtract the purchases of property, plant, and equipment line from the investing section. If OCF is $53,600 and CapEx is $22,900, free cash flow is $30,700.
Not by itself. Negative FCF caused by shrinking operating cash flow is a warning sign, but negative FCF caused by heavy growth investment can be healthy — the firm is choosing to spend more than it generates this year. Check whether operating cash flow is rising and what the CapEx is buying.
Plain FCF (OCF − CapEx) is the simple textbook version. FCFF is unlevered — cash for all capital providers, so interest is added back after tax. FCFE is levered — cash for shareholders only, so you also add net borrowing. With no debt, all three are equal.
In the investing section of the statement of cash flows, usually labeled "purchases of property, plant, and equipment." Do not use the investing section total, which also includes acquisitions and securities purchases.
Net income follows accrual rules: it deducts non-cash charges like depreciation, ignores cash tied up in working capital, and spreads CapEx over years as depreciation. Free cash flow counts only actual cash, so a firm can report positive net income and negative free cash flow in the same year.
By the FinanceBrain Team · Last verified July 11, 2026 · How we produce and verify articles