Free Cash Flow (FCF) is the cash generated by operations that is available for distribution to all investors (both debt holders and stockholders) after the firm makes the investments needed to support operations. A company’s value in DCF depends on the level and growth of FCF.
Use the prior-year and current-year balance sheets plus the current-year income statement. Key point: some working-capital changes require a sign change.
| Cash Flow Statement Line | Where it comes from | Notes / Sign rules |
|---|---|---|
| Cash at beginning of year | Last year’s Balance Sheet | Equals last year’s cash ending balance |
| Net income | Income Statement (current year) | Starting point for CFO |
| + Depreciation | Income Statement / Notes | Non-cash expense added back |
| −/+ Δ Accounts Receivable (AR) | Balance Sheet: AR (current − last) | Change sign: increase in AR reduces cash |
| −/+ Δ Inventory | Balance Sheet: Inventory (current − last) | Change sign: increase in inventory reduces cash |
| +/− Δ Accounts Payable (AP) | Balance Sheet: AP (current − last) | No sign change: increase in AP increases cash |
| Net cash from operations (CFO) | Subtotal | Cash generated by core operations |
| Cash from investing (CFI) | Balance Sheet: Net fixed assets (NFA) | Use Δ(NFA) and add back depreciation to infer CapEx. Change sign for investment outflows. |
| Cash from financing (CFF) | Balance Sheet: LT debt, common stock; IS dividends | Debt/equity issuance positive; dividends are cash outflow |
| Cash at end of year | Balance Sheet (current year) | Must match current-year cash on the BS |