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What is Free Cash Flow?

Definition of Free Cash Flow

The actual cash a company has leftover after paying all of its expenses, including operating costs, taxes, and investments in real estate, buildings, equipment, and working capital. This number is important to shareholders because it is the cash that is available at the end for disbursement in the form of dividends. Free cash flow will usually be lower than a company's earnings because of depreciation. For example, if a company makes a large investment in a piece of equipment, they can depreciate the cost over several years, and therefore avoid significantly affecting the earnings figure on the income statement for any one year. However the cash usually is paid all in one year, and will therefore significantly decrease the company's free cash flow. Because of this, many see free cash flow as a better measure of a company's ability to earn profits over the course of the year. It is important to note, however, that a negative free cash flow is not necessarily a bad thing. New, growing companies will often be spending a lot of money on investments and therefore use all their cash. This could be positive if the investments have the potential to earn a high return in the future.
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