Top Stories | Wed, 18 Dec 2024 05:01 PM

Top 20 FCF (free cash flow) interview Q&A

Posted by : SHALINI SHARMA

Free Cash Flow (FCF): Free cash flow measures the cash it generates after paying for capital expenditures to maintain or expand its asset base. It is one of the most critical measures of financial health for a company, measuring how profitable it is and how much cash a company produces, which could be used for dividends, debt repayment, or reinvestment. FCF is calculated using the formula:

FCF = Operating Cash Flow – Capital Expenditures

Importance of Free Cash Flow

1.Financial Health Indicator: Free Cash Flow shows how financially healthy a company is because it denotes the money that is left after operational expenditure and capital expenditures. It states whether the company can generate enough cash to pay off its dues, such as debt repayments and operational needs. High FCF gives enough assurance to stakeholders on the financial stability of the company.

2.Investment Decisions: Free cash flows have been analyzed most closely by the analysts and investors when they determine a company's importance for stable growth or underperformance in measuring effects over time. Positive and constant FCF indicates that a company has enough cash to reinvest for new projects, to expand its operations, or for strategic acquisitions. Hence, it also becomes an important factor while exploring long-term investments.

3.Dividends and Buybacks: A company with high free cash flow is able to reward its shareholders by paying them off dividends regularly through share buy-backs. Thus, dividends are a form of giving surplus cash to investors. Conversely by reducing the number of outstanding shares by buy-backs one improves earnings per share. Both these ways improve shareholder value and confidence in the market.

4.Debt Management: Free Cash Flow guarantees that a company has sufficient resources to fulfil its requirements for management of debt obligations. Strong Free Cash Flow makes it easier for companies to make timely interest payments and pay back principal loan amounts. This thus reduces the financial risk and improves the creditworthiness of these companies, making them enjoy lower future borrowing costs.

1.What does Free Cash Flow (FCF) indicate?

Free Cash Flow, which shows the amount by which the company cashes after its operational costs and capital expenditures. Being a measure of how much it incurs into real cash flow, it is usually used in measuring the effects of a company's financial flexibility.

2.How is Free Cash Flow different from Net Income?

It includes the effects of its non-cash items and accrual-based accounting in calculating the net income; however, the FCF is based purely on cash left after necessary capital investments.

3.How is FCF calculated?

FCF is calculated as:

Operating Cash Flow - Capital Expenditures. 

  This formula adjusts net cash from operations by subtracting investments in fixed assets.

4.What are Capital Expenditures? 

Capital Expenditures (Capex) are the amounts paid by a company to acquire or maintain physical assets such as buildings, machinery, or technology. It refers to outflows of cash for long-term investments.

5.Why is FCF considered important for investors?

Investors prefer FCF because it reflects a company's real cash-generating ability, which can be used for dividends, share buybacks, or growth. Unlike profits, FCF focuses on liquid cash flow.

6.What’s the difference between FCF and EBITDA?

EBITDA includes capital expenditures and changes in the working capital while FCF leverages the last. FCF gives you the better insight into liquidity, while EBITDA gives you that view over operating profitability.

7.What is Adjusted Free Cash Flow?

Adjusted free cash flow is that free cash flow which is adjusted for extraordinary events or one-off expenses. This gives a truer picture of the cash flows of a company.

8.Can a company have positive Net Income but negative FCF?

Yes, a company can report net positive income, but one can still be said to have negative FCF, which means that there are high capital expenditures or some major shifts in working capital, thus holding back cash.

9.How is FCF used in valuation models?

FCF plays a role in valuation methodologies, such as Discounted Cash Flow (DCF), in terms of estimating intrinsic value for the firm and developing projections of future cash flows.

10.What are the limitations of using FCF?

Limitations include its dependency on capital expenditure assumptions and its sensitivity to short-term fluctuations in cash flow. It may not reflect a company’s long-term growth potential.

11.What does negative FCF signify? 

Negative FCF indicates that a company is spending more on capital expenses than it generates in cash, which is not always bad; sometimes it could be an indicator of future growth investment.

12.How does FCF impact dividend policies? 

Directly impacts the possibility of a company paying dividends. A consistently good cash flow indicates that the company can afford dividend payments on a recurrent basis.

13.Why is FCF important in M&A transactions? 

Free cash flow (FCF) is evaluated in mergers and acquisitions since it aids in determining the target company's ability to generate cash for investors. It is often used as one of the indicators to know whether an acquisition is going to be worth it.

14.How do changes in working capital affect FCF? 

Increase in working capital brings down FCF because cash is tied more in operations. On the other hand, decrease in working capital increases FCF as cash is made liquid.

15.What is the relationship between FCF and leverage? 

Companies with strong FCF are better able to manage debt, as available cash becomes sufficient for paying up interest in installments and also for the repayment of principal amount. It reduces financial risk.

16.How can FCF help assess a company’s growth potential? 

High and continuous FCF enables the organization to reinvest more in growth initiatives like R&D, acquisition, or entering new markets. It shows financial solidity and area for growth.

17.Is FCF the same as cash on the balance sheet? 

Cash flow from operations in a given period translates to free cash flow, whereas cash on the balance sheet represents the balance of cash and cash equivalents the company has at a given point in time.

18.What industries typically have high FCF? 

Industries like software and financial services are usually capital light and hence have more free cash flow, while capital-intensive entities such as manufacturing will report lower free cash flow.

19.How do share buybacks relate to FCF? 

Companies with very high free cash flows mostly use such cash to buy back shares, thus reducing the number of shares in circulation. In effect, the earnings per share (EPS) increases at the end of the financial period and rewards shareholders.

20.Can high FCF signal risks? 

Yes, significantly high FCF might indicate low investment in future growth or maintenance of assets. An assessment must be made in terms of whether this high FCF figure is sustainable.