Free cash flow (FCF) is a cash flow available for distribution among all the security holders of a company. They include equity holders, debt holders, preferred stock holders, convertible security holders, and so on.
Free cash flow = (Net Income +Depreciation/Amortization-Changes In Working Capital) cash flow' operations- Capital Expenditure
Explanation
Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. It is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
So it is the cash flow actually available for distribution to all investors (stockholders and debt holders) after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations.
Illustration
ABC ltd has following financial data extracted from income statements, balance sheets , cash flow and notes to accounts.
Net income $ 25,000
Depreciation $ 2,000
Working capital changes +$10,000
Capital expenditure $12,000
Then
Free cash flow = (Net Income +Depreciation/Amortization-Changes In Working Capital) cash flow' operations- Capital Expenditure
Free cash flow = (25,000 + 2,000-10,000) 17,000-12,000
Free cash flow =$5,000
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