Free cash flow, and what it is free of
Free cash flow is the cash left from operations after paying for the assets that keep the business going. It is one of the most quoted numbers in finance, and one of the most loosely defined. This lesson builds it, walks down the claims that still follow it, and tests it on Titan and Info Edge.
- Level
- Beginner
- Reading time
- About 23 minutes
- Know this first
- Direct and indirect cash flow
By the end you will be able to:
- work out free cash flow from a cash flow statement
- list the claims that come after free cash flow and still have to be paid
- compare free cash flow with profit in a real company
- say why the word free can mislead
What "free" means
A business needs cash for two different jobs. One is running today's trade, which the operating section measures. The other is keeping the trade going: replacing worn machines, refitting shops, building new capacity. Some of that second job is optional, but a good deal of it is not. Free cash flow is the cash from operations that remains after the business has paid for its fixed assets.
The sum is one subtraction: cash from operating activities, less the cash spent on property, plant and equipment and intangible assets. Both numbers sit in the cash flow statement you already know how to read.
The word "free" suggests money that is available to do as you like. That is where care is needed. The international standard on cash flow statements, IAS 7, does not define the term, so there is no official definition in the accounts. In the United States, the Securities and Exchange Commission staff note that it "does not have a uniform definition", and warn companies against suggesting it is the cash left for discretionary spending, since many companies have debt payments and other obligations the figure does not deduct. This lesson uses the plain version and walks down the obligations that follow it.
Walk down the claims
Below is a company's year, expressed as a walk down from operating cash. Change what operations produced, what went into assets, the interest and lease payments, and the dividend. The ledger shows what is left at each step, or what is missing.
Operations produced ₹20,00,000 and ₹6,00,000 went into fixed assets, so free cash flow is ₹14,00,000. After ₹2,50,000 of interest and lease payments and ₹5,00,000 of dividends, ₹6,50,000 is left.
Try three experiments. First, raise the spending on assets until it passes cash from operations: free cash flow turns negative. That is not always a warning. A company in the middle of building a factory will show it, and the financing section will show how it paid. Second, put the dividend at its maximum and see how quickly "free" cash disappears into claims that were decided long before. Third, set interest and lease payments to zero and notice how much easier the walk looks. A debt-free company with no leased premises faces a very different test from one that has both.
A real company: Titan
Titan's operating cash flow was ₹2,030 crore in FY2023-24 and ₹1,810 crore in FY2022-23. It spent ₹529 crore and ₹288 crore on property, plant, equipment, intangibles and investment property in those years. Free cash flow was therefore ₹1,501 crore and ₹1,522 crore. Against profit after tax of ₹3,544 crore and ₹3,333 crore, that is 0.42 and 0.46 of profit in each year.
| ₹ crore | FY2023-24 |
|---|---|
| Cash from operating activities | 2,030 |
| Purchase of property, plant, equipment, intangibles and investment property | (529) |
| Free cash flow | 1,501 |
| Finance costs paid | (480) |
| Payment of lease liabilities, excluding interest | (258) |
| Left to cover dividends | 763 |
| Dividends paid | (888) |
| Left after dividends | (125) |
| Acquisition of treasury shares | (236) |
| Left after treasury shares | (361) |
Free cash flow of ₹1,501 crore looks comfortable until the claims arrive. Finance costs paid took ₹480 crore and lease payments ₹258 crore, leaving ₹763 crore. The dividend of ₹888 crore was larger than that, so the walk ends ₹125 crore short, and the purchase of treasury shares, at ₹236 crore, takes it to ₹361 crore short. In other words, Titan's interest, lease payments and dividend together cost ₹1,626 crore, more than the free cash flow that year.
That is not a criticism. The gap was financed. Titan raised ₹4,619 crore of borrowings in the year, and used a good part of its money for something free cash flow does not count at all: ₹4,726 crore of investments in subsidiaries and other equity instruments, many times its spending on fixed assets. A reader who stops at the free cash flow line would see neither the pressure from the claims nor the large purchases of other companies' shares. Both appear in the same cash flow statement, one section down.
A real company: Info Edge
Info Edge's accounts have all the lines for both years. Its operating cash flow was ₹8,323.96 million in FY2023-24 and ₹7,874.71 million in FY2022-23, and its spending on property, plant and equipment and intangibles was ₹257.19 million and ₹578.24 million. Free cash flow was ₹8,066.77 million and ₹7,296.47 million, which is 0.97 and 1.77 times its profit after tax.
| ₹ million | FY2023-24 | FY2022-23 |
|---|---|---|
| Cash from operating activities | 8,323.96 | 7,874.71 |
| Purchase of property, plant and equipment and intangibles | (257.19) | (578.24) |
| Free cash flow | 8,066.77 | 7,296.47 |
| Interest paid on borrowings and on lease liability | (163.08) | (38.81) |
| Repayment of lease liability | (238.97) | (189.37) |
| Left to cover dividends | 7,664.72 | 7,068.29 |
| Dividend paid | (2,452.10) | (1,931.64) |
| Left after dividends | 5,212.62 | 5,136.65 |
| Investment in subsidiaries and joint ventures | (1,522.66) | (10,075.70) |
| Left after investing in subsidiaries | 3,689.96 | (4,939.05) |
Info Edge's claims are small against its cash. Lease payments, with interest, took ₹399.73 million in FY2023-24, and the dividend of ₹2,452.10 million was covered by free cash flow with ₹5,212.62 million to spare. The step that matters is the last one. In FY2022-23 the company invested ₹10,075.70 million in subsidiaries and joint ventures, much more than its free cash flow could pay for, and the walk ends ₹4,939.05 million short. Its investing section shows how it paid: the fixed deposits it held matured, bringing in a net ₹6,789.96 million. In FY2023-24 the investment in subsidiaries was ₹1,522.66 million, and the walk finishes with ₹3,689.96 million to spare.
The same free cash flow figure can sit comfortably in one year and be overwhelmed in the next, depending on what the company chooses to do with it. That is the reason to treat free cash flow as a starting line for the cash questions and not the answer.
Choices hiding in "free"
Because there is no official definition, two people can produce different free cash flow figures for the same company, and both can be defensible. Four choices drive most of the differences.
| Choice | One way | Another way |
|---|---|---|
| What counts as spending on assets | Only the purchase of property, plant and equipment and intangibles | Also investments in other companies, as Titan's and Info Edge's investments in subsidiaries show |
| Interest paid | Leave it in financing, as Titan does, so free cash flow is before interest | Deduct it, so the figure is what is left for the owners |
| Lease payments | Leave them in financing, so free cash flow is before rent on leased premises | Deduct them as a cost of running the business |
| Sales of assets | Ignore the proceeds of selling machines or buildings | Net them against capex |
When you see a free cash flow figure on a website or in a company's presentation, find out which choices were made before comparing it with another. The number in this lesson is the simplest one, and the walk shows how the others would differ.
Free cash flow, same recipe, three companies
Free cash flow is the cash left after the spending needed to keep and grow the business. The simplest recipe takes cash from operations and subtracts capital spending. The table applies it to Apple, Microsoft and Toyota, and then compares the result with net income and with the cash returned to shareholders.
| Latest year, millions | Cash from operations | Capital spending | Free cash flow | Free cash flow as a share of net income | Buybacks and dividends as a share of free cash flow |
|---|---|---|---|---|---|
| Apple | $111,482 | $12,715 | $98,767 | 88.2% | 107.5% |
| Microsoft | $136,162 | $64,551 | $71,611 | 70.3% | 59.4% |
| Toyota | ¥3,696,934 | ¥1,906,811 | ¥1,790,123 | 37.4% | 129.1% |
Toyota's capital spending in the table is the purchase of its own property, plant and equipment. Its other capital spending, on equipment leased to customers, is treated separately in the next section.
Apple's free cash flow of $98,767 million was 88.2% of its net income, and Microsoft's $71,611 million was 70.3%. The gap at Microsoft reflects its heavy spending on property and equipment. Apple returned 107.5% of its free cash flow to shareholders in buybacks and dividends, and Microsoft returned 59.4%, keeping the rest for the business. A figure above 100%, like Apple's, means the company paid out more than it generated from this measure that year, using cash it already held or new borrowing.
When the definition changes the sign
Toyota shows how much the definition of capital spending matters. Its financial services arm buys vehicles and equipment and leases them to customers, and the cash flow statement records that as a separate investing item. Three reasonable ways of defining free cash flow give three very different answers:
- Cash from operations less spending on its own property and equipment: ¥3,696,934 million less ¥1,906,811 million is ¥1,790,123 million.
- Also subtracting equipment bought to lease to others: ¥2,996,920 million more leaves a negative ¥1,206,797 million.
- Also adding the proceeds from selling leased equipment: ¥1,707,899 million of sales brings it to ¥501,102 million.
Nothing is wrong with any of these, and each answers a different question. The first treats the lending and leasing as separate from the manufacturing, the second counts it as a cost of doing business, and the third recognises that part of the cost comes back when leased equipment is sold. The lesson is to state your definition and apply it the same way to each company.
Why accounting rules reach into free cash flow
Two rules in particular change the starting point. First, research and development: under US GAAP it is generally expensed in the year it is spent, so it reduces operating cash flow. Under IFRS, research is expensed but development costs are recognised as an asset once six criteria are met, and the cash spent on that asset is shown in investing. Two companies with the same spending can show different operating cash flow, and different free cash flow, depending on the rulebook, unless the analyst adjusts.
Second, leases. Under IFRS 16, payments on leases are split between interest and repayment of the lease liability, and the repayment is usually reported in financing, outside operating cash flow. Under US GAAP's ASC 842, the payments for operating leases stay within operating cash flow. The company that follows IFRS can therefore report higher operating cash flow for the same rent. The comparison of free cash flow across countries starts by checking where each company reports these items.
Common mistakes
Treating free cash flow as spare money
Interest, lease payments, dividends and repayments of borrowings still have to be met. Titan's free cash flow was smaller than its three main claims in FY2023-24.
Reading negative free cash flow as failure
A business that is investing heavily in growth can show negative free cash flow for years and still be sound, if the investment is well chosen and funded. It can also hide real trouble. The cash flow statement's financing section is where you check how the gap was filled.
Ignoring investments in other companies
Buying shares in subsidiaries and other companies is shown in investing and is excluded from the simple figure. For Titan and Info Edge, that spending was far larger than spending on fixed assets in some years.
Comparing free cash flow of firms with very different leases and debt
A company that rents everything and a company that owns everything have different claims in different sections. The same operating cash does not mean the same headroom.
Using one year as the picture
Capex is lumpy. Titan's spending on fixed assets was ₹288 crore one year and ₹529 crore the next. A single year can flatter or punish a company. Look at several.
Try it yourself
1. A company's cash from operations is ₹50 lakh and it spent ₹18 lakh on fixed assets. What is its free cash flow?
Show the working
₹50 lakh − ₹18 lakh = ₹32 lakh.
2. It also pays ₹8 lakh of interest and lease payments, and a dividend of ₹20 lakh. How much is left?
Show the working
₹32 lakh − ₹8 lakh = ₹24 lakh to cover dividends. After the ₹20 lakh dividend, ₹4 lakh is left.
3. A growing company shows free cash flow of −₹10 crore. Does that mean it is in trouble?
Show the working
Not by itself. It means spending on assets exceeded operating cash by ₹10 crore. Whether that is a problem depends on what the spending bought, whether operating cash is growing, and how the gap was financed: from savings, new shares or borrowing. The financing section of the statement shows which.
4. Using the Titan walk above, did FY2023-24's free cash flow cover finance costs, lease payments and the dividend together?
Show the working
No. The three claims came to ₹480 + ₹258 + ₹888 = ₹1,626 crore, against free cash flow of ₹1,501 crore. The shortfall was ₹125 crore.
Where this is used
- An investor looks at free cash flow over several years to judge how much a business can return to its owners without borrowing.
- A lender compares free cash flow with interest and repayments to see whether the business can service its debt from its own operations.
- A company's board sets its dividend with a view to what free cash flow can sustain through a weaker year.
- A valuation model, covered later in the course, projects free cash flow forward and discounts it to a present value.
Key terms
- Free cash flow
- In this lesson, cash from operating activities less spending on property, plant, equipment and intangible assets.
- Capital expenditure
- Spending on long-lasting assets such as machinery, buildings and software. Often written capex.
- Dividend cover
- How many times a dividend could be paid from a given measure of cash or profit.
- Treasury shares
- Shares of the company held by or for the company itself, bought back from the market.
- Lease liability
- The amount owed under leases, mainly for premises or equipment. Both companies in this lesson show lease payments in financing.
- Subsidiary
- A company controlled by another company.
Questions people ask
Is a high free cash flow always good?
A high figure is welcome, but the reason matters. If it is high because the company has cut spending on assets it needs, it may be borrowing from its own future. Look at capex against depreciation, as the lesson on reading cash flow quality does.
Why not just use profit?
Profit includes non-cash charges and ignores capital spending. A company can show a profit and still have no cash left after replacing its machines. Free cash flow answers a different question, which is how much cash the business generated after keeping itself running.
What is the difference between free cash flow to the firm and to equity?
They differ in whether interest and borrowing are taken into account, which matters for valuation. A later valuation lesson covers them. The plain figure here is a step before both.
Does a company have to publish its free cash flow?
Not under the standards. It is a figure that companies and analysts derive. Where a company does publish it, check how it is defined.
Sources and review
- Titan Company Limited, audited results with statements of cash flows for the year ended 31 March 2024, filed with BSE. Source of cash from operations, spending on assets, finance costs, lease payments, dividends, treasury shares and investments.
- Titan Company Limited, audited standalone and consolidated financial results for the year ended 31 March 2024. Source of profit after tax.
- Info Edge (India) Limited, audited standalone financial statements, Q4 FY24. Source of every Info Edge line.
- Deloitte, SEC Reporting Interpretations Manual, 4.11 Presentation of free cash flow, for the SEC staff's position that free cash flow has no uniform definition and should not be presented as cash available for discretionary spending.
- IFRS Foundation, IAS 7, Statement of Cash Flows, the standard on which the statements used here are based. It describes operating, investing and financing activities, and does not define free cash flow.
- Apple Inc., Form 8-K, Exhibit 99.1: fourth quarter and full-year fiscal 2025 results, filed with the US Securities and Exchange Commission. Source of Apple's statements.
- Microsoft Corporation, Form 8-K, Exhibit 99.1: fourth quarter and fiscal year 2025 results, filed with the US Securities and Exchange Commission. Source of Microsoft's statements.
- Toyota Motor Corporation, FY2025 Financial Summary (IFRS, unaudited, in millions of yen), furnished to the US Securities and Exchange Commission on Form 6-K. Source of Toyota's statements.
- PwC, IFRS and US GAAP: Similarities and differences, internally developed intangible assets, for research and development costs.
- Deloitte, Roadmap: IFRS and US GAAP comparison, 5.7 Leases, for lessee accounting under IFRS 16 and ASC 842.
How the numbers were checked: every line of both companies' cash flow statements was added up and matches the printed section totals, and cash from operations less spending on assets was recomputed from those lines. Each step in the walk is the previous step less one printed line. The calculator was tested against separate arithmetic across thousands of slider combinations.