Free cash flow to the firm: the cash a business frees for everyone who funds it
A valuation starts from the cash a business can pay out to all of its lenders and owners after it has paid tax and funded its own growth. That figure is free cash flow to the firm. This lesson builds it from the income statement, reconciles it to the free cash flow in a company's cash flow statement, and does both for Apple, where the two figures differ by more than a tenth.
- Level
- Beginner
- Reading time
- About 27 minutes
- Know this first
- Dividends, buybacks and payout
By the end you will be able to:
- build free cash flow to the firm from operating profit, tax, depreciation, capital spending and working capital
- explain why interest is left out and tax is charged on operating profit
- reconcile reported free cash flow to free cash flow to the firm
- say why one year of reinvestment can mislead and how to smooth it
The cash that belongs to everyone who funds the business
A business is worth the cash it can hand to the people who fund it. Those people are lenders and owners together, and the cash left for them after the business has paid its running costs, paid tax and put money back into its own assets is called free cash flow to the firm, or FCFF. Some books call it unlevered free cash flow, because it is the cash flow before any effect of borrowing.
The earlier lesson on free cash flow used the figure that appears in a company's own cash flow statement: cash from operations less capital spending. That figure is a good first measure of what a business generates, but it is not the one a valuation needs. It has interest already deducted, it counts some items that are not a cost in cash terms, and it carries the particular mix of debt a company happens to have. FCFF removes the effect of that mix, so the value it produces belongs to the business and not to the way it is financed. This lesson builds it step by step, reconciles it to the reported figure, and does both for Apple.
The formula
EBIT is operating profit before interest and tax. Charging tax on it gives NOPAT, the profit the business would keep after tax if it had no debt at all. Depreciation and amortization are costs in the income statement that involve no cash leaving in the year, so they are added back. Capital spending is cash that does leave and does not appear as a cost in the year, so it is deducted. Finally, growth ties up cash in stock and in money owed by customers, less whatever suppliers and other creditors finance, and that is deducted too.
The last three lines together are the reinvestment: the cash the business puts back to stay the size it is, or to grow. Free cash flow to the firm is NOPAT less reinvestment. A business that needs to reinvest little turns most of its profit into free cash, while one that has to keep building plants and stock turns much less.
Why interest is left out and tax is charged on operating profit
Interest is a payment to a lender, one of the people the cash flow is being measured for. Deducting it would take cash away from one group of funders before measuring what all of them share, and it would make the value depend on how much the company borrowed. The cost of the borrowing is not ignored: it enters later, through the rate at which the cash flows are discounted, which is the weighted average cost of capital.
The tax charge follows the same logic. Real tax is lower for a company with debt, because interest is deductible. To keep the cash flow independent of the borrowing, tax is calculated on operating profit as though there were none, and the saving from interest is counted once, in the after-tax cost of debt inside the discount rate. Counting it in both places would count it twice.
Build the cash flow
Set the sales of the business, its operating margin, its tax rate, depreciation and capital spending as shares of sales, and the cash absorbed by working capital and other items as a share of sales. The left page works from sales down to after-tax profit. The right page turns that profit into cash. The starting values are rounded from Apple's fiscal 2025 accounts, shown below. Figures are rounded to one decimal, so a column can differ from its total by 0.1.
On $416 billion of sales, operating profit of $133.1 billion becomes $111.8 billion after tax. Investing $26.2 billion in assets and working capital leaves $85.6 billion of free cash flow to the firm, 76.6% of after-tax profit.
Four experiments. First, leave everything at the starting values: operating profit of $133.1 billion becomes $111.8 billion after tax, and $85.6 billion of free cash flow remains, 76.6% of the after-tax profit. Second, set the working capital figure to 0%. Free cash flow rises to $110.6 billion, because none of the year's growth in stock and receivables, or fall in other liabilities, takes cash. Third, raise the tax rate to 25%. Free cash flow falls to $73.6 billion, and every dollar of tax comes straight out of it. Fourth, cut the margin to 20%. Free cash flow falls to $43.7 billion, a bigger percentage fall than profit itself, because capital spending and working capital do not shrink with profit. A business with a thin margin keeps a smaller share of each dollar of profit as free cash.
Apple: building the figure from the accounts
Apple's income statement gives operating income of $133,050 million for fiscal 2025. Its effective tax rate, the tax provision divided by income before tax, was 15.6%. In fiscal 2024 it was 24.1%, because that year's tax includes a one-time charge of $10,200 million related to a European State Aid decision, which Apple identified in its results. The cash flow statement gives depreciation and amortization, capital spending, and the changes in operating assets and liabilities.
| Millions of US dollars | Fiscal 2025 | Fiscal 2024 |
|---|---|---|
| Operating income (EBIT) | 133,050 | 123,216 |
| Effective tax rate | 15.6% | 24.1% |
| Less: tax on operating income | 20,769 | 29,684 |
| After-tax operating profit (NOPAT) | 112,281 | 93,532 |
| Add: depreciation and amortization | 11,698 | 11,445 |
| Less: spending on property, plant and equipment | 12,715 | 9,447 |
| Less: cash absorbed by working capital and other operating items | 25,000 | (3,651) |
| Free cash flow to the firm | 86,264 | 99,181 |
| Reinvestment as a share of NOPAT | 23.2% | −6.0% |
In fiscal 2025 Apple turned $112,281 million of after-tax operating profit into $86,264 million of free cash flow to the firm, 77% of it. Capital spending of $12,715 million was only $1,017 million above depreciation of $11,698 million, so almost all the reinvestment came from the $25,000 million absorbed by working capital and other items. In fiscal 2024 the picture was the reverse: working capital released $3,651 million, and free cash flow to the firm was $99,181 million, more than the fiscal 2025 figure even though profit was lower.
Why one year of reinvestment can mislead
Working capital is the line that moves most. The cash flow statement breaks it into the changes in each operating asset and liability:
| Millions of US dollars, as printed in the cash flow statement | Fiscal 2025 | Fiscal 2024 |
|---|---|---|
| Accounts receivable | (6,682) | (3,788) |
| Vendor non-trade receivables | (347) | (1,356) |
| Inventories | 1,400 | (1,046) |
| Other current and non-current assets | (9,197) | (11,731) |
| Accounts payable | 902 | 6,020 |
| Other current and non-current liabilities | (11,076) | 15,552 |
| Cash absorbed (negative) or released (positive) | (25,000) | 3,651 |
The two years are very different. The largest swing is in other current and non-current liabilities: they used $11,076 million of cash in fiscal 2025 and provided $15,552 million in fiscal 2024. The summary statement does not say what lies behind it; the notes in the annual report would. What matters for valuation is that the reinvestment rate, reinvestment as a share of NOPAT, was 23.2% in fiscal 2025 and −6.0% in fiscal 2024. Neither is a rate to project for ever. The two years together average 9.9%, which is far closer to a normal level, and it is what the calculators in the next lessons start from. A careful analysis looks at several years, and asks what the business needs to reinvest to grow at the rate being forecast, which the lesson on discounted cash flow takes up.
Reconciling to the free cash flow in the accounts
Most data sites and many company reports show free cash flow as cash from operations less capital spending. For Apple that was $98,767 million in fiscal 2025, which is $12,503 million, or 13%, higher than free cash flow to the firm. The difference can be explained line by line, and the table shows it.
| Millions of US dollars | Fiscal 2025 | Fiscal 2024 |
|---|---|---|
| Free cash flow as usually reported: cash from operations less capital spending | 98,767 | 108,807 |
| Less: share-based compensation, a cost paid in shares | (12,863) | (11,688) |
| Remove other non-cash items in operating cash flow | 89 | 2,266 |
| Remove the gap between net income and NOPAT (non-operating items and their tax) | 271 | (204) |
| Free cash flow to the firm | 86,264 | 99,181 |
Three items account for it. The largest is share-based compensation of $12,863 million. It is an expense in the income statement that involves no cash, because staff are paid in shares, so the cash flow statement adds it back. But shares given to staff are a real cost to the owners: they dilute them, and a company that wants to hold its share count steady has to spend cash on buybacks to offset it. Treating the compensation as a cost, by not adding it back, is the more careful choice for valuation, and it is the one made here. The other two items are small: other non-cash items in operating cash flow, and the gap between net income and NOPAT, which holds non-operating income, interest and the tax effect on them. Both sides of the table tie exactly, and the build does not move on to the next step unless they do.
The lesson for a reader is to check which definition a free cash flow figure uses before comparing it with another. Two sources can quote different free cash flows for the same company in the same year and both be correct.
What this figure cannot tell you
- It is a record, not a forecast. Valuation needs free cash flow in years to come, built from forecasts of sales, margins and reinvestment.
- The tax rate is a choice. The effective rate, the statutory rate and the rate on the next dollar of profit differ. A one-off item, such as Apple's fiscal 2024 charge, can distort a single year.
- Working capital is noisy. One year can absorb or release a great deal of cash for reasons that will not repeat.
- Leases and other claims need a decision. Whether lease payments are treated as an operating cost or as financing changes the figure, and the amount of debt it is compared with.
- Acquisitions are separate. The cash spent on buying other companies is usually left out of capital spending, and a business that grows by buying others should have it counted.
The same bridge for two global companies
Free cash flow to the firm, FCFF, is the cash a business generates for all of its investors, lenders and shareholders together, before any interest. The usual route starts from operating profit, takes off tax at the company's own rate to get after-tax operating profit, adds back depreciation, and subtracts capital spending and the cash tied up in working capital. The table builds it for Apple and Microsoft from their latest statements.
| Latest year, millions of dollars | Operating profit | Tax rate | After-tax operating profit | Add depreciation | Less capital spending | Less working capital | Free cash flow to the firm | As a share of after-tax operating profit |
|---|---|---|---|---|---|---|---|---|
| Apple | 133,050 | 15.6% | 112,281 | 11,698 | (12,715) | (25,000) | 86,264 | 76.8% |
| Microsoft | 128,528 | 17.6% | 105,869 | 34,153 | (64,551) | (5,350) | 70,121 | 66.2% |
Apple's FCFF of $86,264 million is 76.8% of its after-tax operating profit of $112,281 million, which means it reinvests 23.2%. Microsoft's FCFF of $70,121 million is 66.2% of $105,869 million, so it reinvests 33.8%. Both are generating a large cash surplus, but Microsoft's capital spending takes more of its profit, and that gap matters for valuation: a business that reinvests more must grow faster to justify the same value.
How FCFF differs from the free cash flow already seen
The earlier lesson on free cash flow subtracted capital spending from cash from operations: $98,767 million for Apple and $71,611 million for Microsoft. FCFF gives lower figures, by $12,503 million at Apple and $1,490 million at Microsoft. There are several reasons, and the figures show that the gap is not constant. FCFF starts from operating profit, which is after the cost of share-based pay ($12,863 million at Apple and $11,974 million at Microsoft), while operating cash flow adds that cost back. Operating cash flow also includes interest and other items that sit outside operating profit, and it uses the tax actually paid, not the rate applied to profit. The two measures answer different questions: the cash left for shareholders after financing costs, and the cash the operations produce for all providers of capital.
Why Toyota does not fit the simple formula
Applying the same steps to Toyota is not straightforward, and the reasons are instructive. Its operating profit of ¥4,795,586 million sits beside a finance arm whose lending is part of operations, so the working capital line includes loans to customers. It spends ¥2,996,920 million on equipment leased to others, in addition to ¥1,906,811 million on its own property, plant and equipment, and the profit of companies it accounts for by the equity method sits below operating profit. An analyst would value the manufacturing and the financial services separately, and add the equity-accounted investments at their own value.
Leases change the cash flow
The accounting for leases changes the figure. Under IFRS 16, a lessee records all leases as a right-of-use asset and a lease liability, and the income statement shows depreciation and interest. The repayment of the liability is a financing cash flow, so FCFF excludes lease payments and the lease liability has to be counted as debt when moving from enterprise value to equity value. Under US GAAP, operating leases keep a single lease cost within operating profit, so FCFF is after the rent. The same leased building can therefore produce a higher FCFF at an IFRS company and a lower one at a US company, and the consistent comparison either puts all leases in debt or treats all of them as an operating cost.
Common mistakes
Deducting interest
Free cash flow to the firm is before payments to lenders. Interest belongs in the discount rate.
Using the tax actually paid
Tax is charged on operating profit. The tax paid by a company with debt is lowered by interest, and using it counts that saving twice.
Adding back share-based compensation without thinking
It is a cost to owners. If it is added back, the dilution has to be allowed for another way.
Projecting a single year's working capital
A year that absorbed or released unusual cash gives a misleading rate. Use an average, or link it to growth.
Mixing definitions
Comparing one company's cash from operations less capital spending with another's FCFF gives a difference that is definition, not business.
Try it yourself
1. A business has operating profit of $200 million and a tax rate of 20%. Depreciation is $30 million, capital spending $50 million, and working capital absorbs $10 million. What is free cash flow to the firm?
Show the working
NOPAT = 200 × (1 − 0.20) = 160. Free cash flow = 160 + 30 − 50 − 10 = $130 million.
2. What is the reinvestment rate in question 1?
Show the working
Reinvestment = 50 − 30 + 10 = $30 million. Divided by NOPAT of 160 it is 18.75%. Equivalently, free cash flow is 130 ÷ 160 = 81.25% of NOPAT, and the two add to 100%.
3. The business borrows heavily and pays $40 million of interest. Does its free cash flow to the firm change?
Show the working
No. Free cash flow to the firm is before interest. The borrowing changes what is left for the owners after the lenders are paid, and it changes the discount rate, but not this figure.
4. A company reports cash from operations of $500 million and capital spending of $120 million, and its operating cash flow includes $60 million of share-based compensation added back. By how much does free cash flow fall if the compensation is treated as a cost?
Show the working
Reported free cash flow is 500 − 120 = $380 million. Treating the $60 million as a cost leaves $320 million, about 16% lower, before any other adjustments.
Where this is used
- An analyst forecasts free cash flow to the firm and discounts it to value a whole business.
- A buyer in a takeover builds it to see what a target generates for lenders and owners together, whatever its current debt.
- A lender compares it with a company's debt payments to judge how safely they can be met.
- A board checks that a plan to grow does not need more reinvestment than the business can fund.
Key terms
- Free cash flow to the firm (FCFF)
- Cash left for lenders and owners together after tax on operating profit and reinvestment.
- NOPAT
- Net operating profit after tax: operating profit less tax charged as though the business had no debt.
- EBIT
- Earnings before interest and tax, or operating profit.
- Reinvestment
- Capital spending less depreciation, plus the cash absorbed by working capital.
- Reinvestment rate
- Reinvestment as a share of NOPAT.
- Unlevered
- Measured before any effect of borrowing.
- Share-based compensation
- Pay given in shares or share awards, a non-cash expense that dilutes owners.
Questions people ask
Is free cash flow to the firm the same as free cash flow to equity?
No. Free cash flow to equity is what is left for owners after lenders have been paid interest and principal. Free cash flow to the firm is the cash before lenders, and is discounted at the cost of capital, not the cost of equity.
Why not just use net income?
Net income is after interest, includes non-cash charges, and ignores the cash spent on assets and working capital. A growing business can report high profit and little free cash.
Can free cash flow to the firm be negative?
Yes, and it often is for a young business that reinvests more than it earns. Valuing it then depends on when the cash flow turns positive.
Should operating leases be treated as debt?
A consistent analysis either treats lease payments as an operating cost and leaves lease liabilities out of debt, or treats the leases as debt and adds back the interest part of the payments. The choice should match the debt figure used later.
Sources and review
- 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 the income statement, balance sheet and cash flow statement figures.
- Corporate Finance Institute, Free cash flow to firm (FCFF), for the definition and the formula from NOPAT.
- 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.
- Deloitte, Roadmap: IFRS and US GAAP comparison, 5.7 Leases, for lessee accounting under IFRS 16 and ASC 842.
How the numbers were checked: Apple's income statement, balance sheet and cash flow detail were tied out by code before use, including that every operating cash flow line adds to the reported total for both years. Free cash flow to the firm was built in two ways, from NOPAT and from reported free cash flow, and the two agree to the dollar. The calculator was tested against separate arithmetic for nearly a thousand combinations of inputs, including that the profit and cash sides always add to the reported total.