The formula for free cash flow (FCF) is:
FCF reflects the amount of cash free for distribution to both debt and equity shareholders.
The formula for FCF yield to equity holders is:
Free cash flow to equity holders/adjusted enterprise value.
The level of FCF does not always reflect the health of a business or its prospects.
For example, a large amount of FCF can be a sign that a company has limited investment opportunities and, hence, limited growth prospects.
On the other hand, negative FCF can be an attractive indication that a company has more investment opportunities than it can fund with cash from operations.
Zero FCF could mean that the company generates just enough cash to internally fund its growth opportunities.
Below, we show how our approach to free cash flow compares with traditional approaches. You can download a copy of this exhibit here.