Free cash flow (FCF) is the cash a business generates after covering both its operating costs and the capital expenditure needed to maintain the business. Unlike profit or EBITDA, it reflects the cash that is actually available — to pay down debt, return to owners, or reinvest. It is the figure a discounted-cash-flow (DCF) valuation is built on, and the cash a lender looks to for debt service.
The free cash flow formula
The simplest version:
- FCF = Operating cash flow − Capital expenditure
The build-up version (unlevered free cash flow, i.e. before financing):
- FCF = EBIT × (1 − tax rate) + Depreciation & Amortisation − Capital expenditure − Change in net working capital
Levered vs unlevered FCF
- Unlevered FCF (FCFF) is the cash available to all capital providers — debt and equity — before interest. It is what enterprise-value DCFs discount.
- Levered FCF (FCFE) subtracts interest and net debt repayment, leaving the cash available to equity owners.
A worked example
| Line | Amount |
|---|---|
| Operating cash flow | $500,000 |
| − Capital expenditure | ($120,000) |
| Free cash flow | $380,000 |
That $380k is what the business can use to service acquisition debt, pay the owner, or reinvest — the number that tells you whether a deal's financing actually works.
Why FCF matters in an acquisition
EBITDA can flatter a capital-intensive business; FCF cannot, because it nets out the capex and working-capital reality. When you finance a purchase, the DSCR a lender checks is driven by cash flow, not accounting profit.
The GradeThisDeal valuation calculator lets you enter free cash flow and folds it into the financial-health score and the financing/DSCR math.