Free cashflow (FCF) is the amount of cash left after a company pays for operating expenses and capital expenditure during a fiscal.1.
Why is it important to track FCF during a financial analysisFinancial parameters such as turnover and profit may suffer from manipulative accounting but, cash generated from operations has a lesser probability of being camouflaged through accounting treatment.
Therefore, investors need to pay attention to FCF while comparing different companies across a sector over a number of years.2.
How to interpret FCF readingsRising FCF is a good sign since it suggests that the company is generating excess cash that can be re-invested back in the business.
It means the company has a reasonable amount of funds for its future growth.
But negative free cash flow reflects company is not able to generate sufficient cash to support its business.3.
How to compare FCF growth with the growth in net profitOver a long term, investors need to watch whether the growth in net profit and that of FCF is in sync.
If the profit growth is way higher than FCF growth over the years, the company may suffer from cash shortage and the profit-loss account may not provide the true picture of solvency and financial strength of the company.4.
What should long-term investors consider when it comes to FCFLong-term investors typically seek higher exposure to companies with healthy improvement in FCF over the years.
Such companies tend to report moderate growth during an economic upcycle while outperforming in the downcycle.
A sustained stream of FCF means that a company is better equipped to reduce debt, pay dividend and employ cash for growth.