Free cash flow: meaning, how it works in India and examples

Free cash flow, often written FCF, is cash from operations minus capital expenditure, or capex. Cash from operations is the money the core business brings in and pays out in a year. Capex is spending on things that last, such as machines, servers, warehouses and capitalised software.

What is left is free, in the sense that the company can use it to repay debt, pay owners or build up reserves without damaging the business. A positive figure means the business funds itself. A negative figure means it needs outside money.

Start with profit before tax or profit after tax from the statement of profit and loss. Add back costs that did not use cash, such as depreciation and employee stock option expense. Adjust for changes in working capital: money tied up in unsold stock and unpaid bills raises the need for cash, while payments received early or delayed payment to suppliers frees it. The result is cash from operations. Then subtract capex.

A simple case: if a company has cash from operations of ₹80 crore and spends ₹30 crore on capex, its free cash flow is ₹50 crore.

• Start with profit.
• Add back non-cash costs such as depreciation.
• Adjust for working capital changes.
• Result: cash from operations.
• Subtract capital expenditure to get free cash flow.

Profit after tax is an accounting figure that counts income when it is earned and costs when they are incurred, not when cash moves. EBITDA is earnings before interest, tax, depreciation and amortisation, and it leaves out capex entirely. A company can post a profit and still run short of cash if customers pay late or if it keeps buying equipment.

Free cash flow is the strictest of the three. It cannot be changed as easily by accounting choices, which is why many investors look at it next to profit. The guide on EBITDA and profitability explains the other two measures.

Yes. A fast-growing company may sell on credit, so profit is recorded but cash has not arrived. It may build stock ahead of a festival season. It may also spend heavily on new factories. Each of these lowers free cash flow while profit looks healthy.

The opposite also happens: a company with a small loss may produce positive cash flow if it collects payment in advance, as subscription and prepaid businesses do.

Companies prepare a cash flow statement as part of their financial statements. Under Ind AS 7, the standard on statement of cash flows, activities fall in three parts: operating, investing and financing. Cash from operating activities is the starting point. Purchases of property, plant, equipment and intangible assets appear in investing activities, and that is where capex is found. Financing activities show loans and share issues.

The Companies Act, 2013 includes the cash flow statement in financial statements, but with exceptions for certain small companies and some other categories. Listed companies publish it in their annual results. Private startups file their accounts with the Registrar of Companies, where they can be bought from the MCA site.

For a loss-making startup, cash burn, also called negative free cash flow, decides how long the money lasts. The guide on burn rate and runway covers this. When a startup says it has turned free cash flow positive, it means it no longer needs fresh funding to run the current business.

Such claims should be read carefully. Some firms exclude capex or one-off costs from their number, and some report a single quarter. Look for the period, the basis and whether lease payments are counted.

Several well-known new-age companies have said, in their results or investor communication, that they reached cash-flow break-even or turned positive for a quarter or a year after years of losses. Those claims usually come with a definition, such as cash from operations after lease payments, or a figure before one-off costs. Because each firm may define the term in its own way, comparing two companies on the claim alone is risky.

The safest approach is to go to the cash flow statement and compute the figure yourself: take cash from operating activities and subtract purchases of fixed assets and intangible assets. A short, careful calculation from filed numbers is better than a headline.

Three items often cause confusion. The first is lease payments. Under Ind AS 116, the standard on leases, the principal part of a lease payment is shown in financing activities, which makes operating cash flow look better than it would if rent were treated as a running cost. Many analysts subtract lease payments to get a cleaner free cash flow.

The second is interest. Under Ind AS 7, a company can choose where to show interest paid, so two firms may place it in different sections. The third is tax paid, which usually sits inside operating cash flow. When a figure looks surprisingly good, check these three before trusting it.

• Lease principal: shown in financing, so subtract it for a stricter view.
• Interest paid: classified by choice, so check the notes.
• Tax paid: usually in operating activities.
• Capitalised software: counted in investing, which is part of capex.

Compare free cash flow to revenue, which gives a margin, and compare it across several years instead of one. A steady improvement says more than a single positive quarter. Put it next to the cash balance too: a company with a large negative figure but a large cash balance may have years of runway, while a small negative figure with little cash is more urgent.

Used this way, the figure becomes a quick check on a startup story. If the headline claims a company has stopped burning money, the cash flow statement should show it, and the cash balance in the balance sheet should stop falling for reasons other than a planned purchase.

Check whether the number is free cash flow, operating cash flow or EBITDA, since they are often confused. Check whether it is a year or a quarter. A company can say it is cash-flow positive for one quarter and still have a negative year. Also check whether interest paid and lease payments were counted, since two analysts can reach different totals from the same statement. This is general information, not investment advice.