What are free cash flows? What is a quick and dirty method for figuring out free...

What are free cash flows? What is a quick and dirty method for figuring out free cash flows? Why are free cash flows so important in finance?

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Expert Solution

The difference between the money generated from operations and money invested in operations is known as free cash flow.

The quick method to calculate the free cash flow is given as

Free cash flow = Operating income - change in net operating assets

A different method to calculate the free cash flow is given as

Free cash flow = Net financial expense - Change in net financial obligations + Net dividends

Free cash flow can be defined as the amount of money generated or consumed by a business. Whenever a business generates money, it has a positive free cash flow that can be distributed to the owners as dividends or reinvested in the business. A business that consumes money represents a shortfall and the firm has to borrow from lenders to make up for the shortfall.

Thus free cash flows are very important in finance because it helps in determining the economic viability of a project and based on the viability a decision can be made whether to undertake or abandon the project.

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