Thread: Free Cash Flows and It's importance
We hear this thing a lot times where analysts/management talks about free cash flows generated by the company. Well let us help you out with this concept today.
We hear this thing a lot times where analysts/management talks about free cash flows generated by the company. Well let us help you out with this concept today.
When a company sells it's products and services, It get paid in form of cash. This cash is used for running the business i.e. paying to suppliers, salary to employees, taxes to government, purchase of fixed assets & dividends to shareholders.
A company needs to invest large amounts of cash into purchase of fixed assets to grow the business. Here comes the concept of free cash flow (FCF).
FCF is the cash generated by company from it's operating activities after reducing the amount spent on purchase of fixed assets.
FCF is the cash generated by company from it's operating activities after reducing the amount spent on purchase of fixed assets.
Eg:
Suppose a company generates Rs. 1500 crores from it's operations (Cash flow from operating activities) and purchases fixed assets worth Rs. 300 crores in that year. The free cash flow will be Rs. 1200 crores.
Suppose a company generates Rs. 1500 crores from it's operations (Cash flow from operating activities) and purchases fixed assets worth Rs. 300 crores in that year. The free cash flow will be Rs. 1200 crores.
This figure is important because it tells us about the cash leftover with the company for distribution to shareholders/repayment of debt etc.
Tip: A company might have cash flow from operations but not free cash flows.
Tip: A company might have cash flow from operations but not free cash flows.
This could be due to company being in expansion phase where company is investing a lot of money generated by it in fixed assets. An investor should check whether the sales and profits are growing with the expansion in fixed assets to see if the cash is deployed in prudent manner.
