How to Calculate Free Cash Flow: Define CAPEX First
Explore the basic calculation of operating cash flow minus capital expenditure and the differences between free cash flow definitions. Compare intangible asset purchases, asset sales, and lease payments carefully.
Free cash flow is commonly calculated as operating cash flow less capital expenditure. It is an analytical measure whose value changes depending on which acquisition expenditures and disposal proceeds are included. Before comparing figures, reconcile the company's definition with the scope of your own calculation.
Why you should not simply subtract total investing cash flow
Investing cash flow can include purchases and sales of financial instruments and business acquisitions and disposals as well as equipment purchases. Adding the whole amount to operating cash flow can make a one-time asset sale look like an increase in recurring cash generation. First identify cash purchases of property, plant and equipment in the cash flow statement, then specify whether purchases of intangible assets are included. If expenditure is presented as a negative number, double-check the sign when subtracting it. Cash raised through borrowing or equity issuance is easier to interpret separately in a financing schedule rather than as operating cash generation.
Account for intangible assets and leases when comparing businesses
A company spending cash on software development and one buying machinery use different investment accounts. Deducting only purchases of property, plant and equipment can make companies that capitalize development spending appear to have more cash available. Businesses that buy equipment outright and those that lease it also have different payment patterns and require separate comparison. Distinguish noncash asset acquisitions absent from the cash flow statement from current cash deductions, and incorporate them into future payment commitments. Keep both reported and adjusted figures when making adjustments rather than selecting only favorable measures.
Free cash flow is not the same as cash available for dividends
Even positive free cash flow may face debt maturities, essential inventory purchases, and already contracted investment spending. Check whether temporary customer advances or delayed payments inflated operating cash flow. Conversely, if building a factory for growth makes free cash flow negative, assess the investment's profitability and the company's financing capacity; the negative figure alone does not indicate failure. Relating cumulative free cash flow over several years to changes in net debt helps show whether the remaining cash went to dividends, acquisitions, or cash accumulation. If lower spending raised free cash flow, seek evidence distinguishing deferred maintenance from greater investment efficiency. Tracking the gap between investment plans and actual spending in the next report is useful.
Worked example
Hypothetical example: With operating cash flow of KRW 18 billion, cash purchases of property, plant and equipment of KRW 7 billion, and cash purchases of development-related intangible assets of KRW 2 billion, free cash flow after both types of purchases is KRW 9 billion. A definition that also includes KRW 1.5 billion of separate equipment disposal proceeds gives KRW 10.5 billion. When comparing recurring operating capacity, present the KRW 9 billion and the KRW 1.5 billion disposal effect separately. The two figures reflect different definitions rather than a calculation error.
What to check
- Have you listed the cash purchase accounts included in CAPEX?
- Have you separated business acquisitions and financial instrument transactions?
- Do leases and capitalized development costs distort the comparison?
- Are debt maturities and contracted investment payments still outstanding?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.