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Zitat:Free Cash Flow is the lifeblood of every company.
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Definition and Importance
- 𝗗𝗲𝗳𝗶𝗻𝗶𝘁𝗶𝗼𝗻: Free Cash Flow is the cash produced by a company through its operations, after subtracting the capital expenditures (CapEx) necessary to maintain or expand the asset base.
- 𝗜𝗺𝗽𝗼𝗿𝘁𝗮𝗻𝗰𝗲: FCF is a key indicator of a company's ability to generate cash, which can be used to pay dividends, repay debt, or reinvest in the business for growth.
𝗖𝗮𝗹𝗰𝘂𝗹𝗮𝘁𝗶𝗼𝗻
FCF can be calculated using the following formula:.
𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 = 𝗢𝗽𝗲𝗿𝗮𝘁𝗶𝗻𝗴 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 - 𝗖𝗮𝗽𝗶𝘁𝗮𝗹 𝗘𝘅𝗽𝗲𝗻𝗱𝗶𝘁𝘂𝗿𝗲𝘀
There are primarily two types of Free Cash Flow used in valuation:
1. 𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 𝘁𝗼 𝘁𝗵𝗲 𝗙𝗶𝗿𝗺 (𝗙𝗖𝗙𝗙): Represents the cash flow available to all the company's capital providers, including bondholders and stockholders.
2. 𝗙𝗿𝗲𝗲 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 𝘁𝗼 𝗘𝗾𝘂𝗶𝘁𝘆 (𝗙𝗖𝗙𝗘): Represents the cash flow available to the company's shareholders after all expenses, reinvestments, and debt repayments.
Components:
- 𝗢𝗽𝗲𝗿𝗮𝘁𝗶𝗻𝗴 𝗖𝗮𝘀𝗵 𝗙𝗹𝗼𝘄 (𝗢𝗖𝗙): Cash generated from the company's regular business operations, found on the cash flow statement.
- 𝗖𝗮𝗽𝗶𝘁𝗮𝗹 𝗘𝘅𝗽𝗲𝗻𝗱𝗶𝘁𝘂𝗿𝗲𝘀 (𝗖𝗮𝗽𝗘𝘅): Investments in physical assets like property, plant, and equipment (PP&E), also reported on the cash flow statement.
Significance
• 𝗘𝘃𝗮𝗹𝘂𝗮𝘁𝗶𝗻𝗴 𝗣𝗲𝗿𝗳𝗼𝗿𝗺𝗮𝗻𝗰𝗲: A positive FCF indicates that a company has sufficient funds for expansion, dividends, and debt reduction, whereas a negative FCF may suggest financial troubles or significant investments in CapEx for future growth.
• 𝗜𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁 𝗔𝗻𝗮𝗹𝘆𝘀𝗶𝘀: Investors closely monitor FCF as it provides insight into a company's financial strength, operational efficiency, and growth potential.
• 𝗩𝗮𝗹𝘂𝗮𝘁𝗶𝗼𝗻 𝗠𝗼𝗱𝗲𝗹𝘀: FCF is a critical input in various valuation models, including the Discounted Cash Flow (DCF) analysis, used to estimate the present value of a company's future free cash flows.
Limitations
While FCF is a valuable financial metric, it has limitations:
- 𝗡𝗼𝘁 𝗮 𝗖𝗼𝗺𝗽𝗿𝗲𝗵𝗲𝗻𝘀𝗶𝘃𝗲 𝗠𝗲𝗮𝘀𝘂𝗿𝗲: FCF does not account for all cash needs, such as mandatory debt repayments.
- 𝗩𝗼𝗹𝗮𝘁𝗶𝗹𝗶𝘁𝘆: FCF can be volatile and influenced by seasonal business cycles or irregular capital expenditure requirements.
- 𝗖𝗮𝗽𝗶𝘁𝗮𝗹 𝗦𝘁𝗿𝘂𝗰𝘁𝘂𝗿𝗲 𝗜𝗴𝗻𝗼𝗿𝗮𝗻𝗰𝗲: FCF does not directly consider the company's capital structure or the cost of capital.
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