What Is Free Cash Flow and Why Is It Important?

Options Trading Podcast

You’ve heard the saying: "Profits lie, cash doesn't." A company can hit record earnings and look amazing on paper, but still be teetering on the edge of going broke. How is that possible?

What is free cash flow and why is it important?

In this deep dive, we put on our financial detective hats to find the real story of a company's health. We're cutting through the accounting fog to focus on Free Cash Flow (FCF)—one of the most honest metrics available.

You'll learn what FCF is, how it cuts through misleading "on paper" profits from accrual accounting, and how to calculate it yourself using the cash flow statement (Operating Cash Flow - Capital Expenditures). We also explain what FCF tells you about a company's true financial muscle, including its ability to pay dividends, pay down debt, and reinvest in growth. We'll also cover advanced concepts like FCF Yield and the FCF Payout Ratio, the ultimate test for dividend safety.

After listening, how will focusing on FCF change the way you analyze a company's health?

Key Takeaways

• FCF is the "Real" Spendable Cash: Free Cash Flow (FCF) is the cash a company has left over after paying for all day-to-day operations and investing in its assets (capital expenditures). It's the actual, "free and clear" cash management can use.
• "Profits Lie, Cash Doesn't": Reported earnings (profits) can be misleading due to accrual accounting, which records revenue before cash is received. FCF cuts through this by tracking only the actual cash that moved in and out of the business.
• Why FCF is Key: FCF shows a company's true ability to pay dividends, pay down debt, buy back stock, and reinvest in the business using its own cash (without needing to borrow).
• Context is King for Negative FCF: Negative FCF (burning cash) isn't always bad. It can be a strategic choice for high-growth companies (like early Amazon) that are pouring every penny back into future growth.
• The Ultimate Dividend Safety Check: The FCF Payout Ratio (Dividends Paid / Free Cash Flow) is a more reliable measure of dividend safety than the standard earnings payout ratio. If it's over 100%, the company is borrowing to pay its dividend.

"A company can look amazing on paper, profit wise, and still be teetering on the edge of going broke. How does that even happen?"

Timestamped Summary

• (01:46) What is Free Cash Flow (FCF)? (The formula: Operating Cash Flow - Capex)
• (02:50) "Profits Lie, Cash Doesn't": FCF vs. Misleading Earnings (Accrual Accounting)
• (03:38) Why FCF is a Key Metric (Dividends, Debt, Reinvestment)
• (05:36) Is Negative FCF Always Bad? (Context is King)
• (06:35) How to Find and Calculate FCF (Using the Cash Flow Statement)
• (12:09) The Ultimate Dividend Safety Check (FCF Payout Ratio)

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