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Free Cash Flow Formula: Calculation & Examples

Published February 21, 2026 Updated February 21, 2026 by Vicky Sarin

Free Cash Flow (FCF): The Complete Guide to Formula, Calculation & Examples

Free cash flow (FCF) is the cash a business generates from its operations after paying for capital expenditures — it is the truest measure of how much cash a company produces that can be returned to investors, used to repay debt, or reinvested for growth. The free cash flow formula is: FCF = Operating Cash Flow − Capital Expenditures.

💡 Key Takeaways

The core free cash flow formula is: FCF = Operating Cash Flow − Capital Expenditures (Capex)
Free Cash Flow to the Firm (FCFF) measures cash available to all capital providers — debt and equity — before financing payments.
Free Cash Flow to Equity (FCFE) measures cash available to shareholders only, after debt payments have been made.
The most common FCFF error is deducting interest expense — FCFF is calculated before interest, using NOPAT or EBIT × (1 − tax rate).
When using FCFF to value equity, you must subtract net debt from enterprise value — forgetting this step overstates equity value.

Table of Contents

What Is Free Cash Flow (FCF)?
The Free Cash Flow Formula: Three Methods
FCFF vs FCFE: Key Differences Explained
How to Calculate Free Cash Flow: Step-by-Step with Example
Common Free Cash Flow Mistakes to Avoid
How Free Cash Flow Is Used in DCF Valuation
Free Cash Flow in ACCA AFM: What You Need to Know
Frequently Asked Questions

What Is Free Cash Flow (FCF)?

Free cash flow (FCF) is the cash remaining after a business has paid its operating expenses and capital expenditures. Unlike net income, which includes non-cash items and accounting adjustments, FCF represents actual cash generated — making it the preferred metric for investors, analysts, and valuation models including discounted cash flow (DCF).

FCF is considered a superior measure of financial health because it strips away the distortions of accrual accounting. A company can report strong net profit while simultaneously burning through cash — FCF exposes that gap. Conversely, a company with modest net income but high FCF is often generating excellent economic value.

"The most important thing in evaluating a business is whether it generates cash. Profits are an opinion; cash is a fact." — Alfred Rappaport, Harvard Business Review

FCF has three main applications in finance: valuing a business (DCF analysis), assessing financial flexibility (ability to pay dividends, repay debt, make acquisitions), and evaluating management's capital allocation decisions. For ACCA AFM candidates, FCF is the starting point for nearly every business valuation and investment appraisal question.

The Free Cash Flow Formula: Three Methods

There are three commonly used free cash flow formulas — each starts from a different line on the financial statements but should produce the same result. Choosing the right starting point depends on what data is available in the question or financial model.

Method 1 — From Operating Cash Flow (Simplest)

FCF = Operating Cash Flow (CFO) − Capital Expenditures (Capex)

Method 2 — From Net Income

FCF = Net Income + Depreciation & Amortisation − Change in Working Capital − Capex

Method 3 — From EBIT (Used in ACCA AFM & DCF Models)

FCF = EBIT × (1 − Tax Rate) + D&A − ΔWorking Capital − Capex

Note: EBIT × (1 − Tax Rate) = NOPAT (Net Operating Profit After Tax). This is unlevered FCF — it excludes interest and is used when building a FCFF-based DCF model.

✅ Pro Tip: In ACCA AFM exam questions, you will almost always be given EBIT or operating profit figures — not a cash flow statement. Default to Method 3 (EBIT-based) for exam calculations, and remember to add back depreciation since it is a non-cash charge already deducted from EBIT.

FCFF vs FCFE: Key Differences Explained

Free Cash Flow to the Firm (FCFF) measures cash available to all capital providers — both debt holders and equity holders — before any financing payments. Free Cash Flow to Equity (FCFE) measures what remains for shareholders only, after interest and debt repayments. The choice between them determines both the cash flow you forecast and the discount rate you apply.

Feature	FCFF (Free Cash Flow to Firm)	FCFE (Free Cash Flow to Equity)
What it measures	Cash available to all providers of capital (debt + equity)	Cash available to equity shareholders only
Formula	EBIT × (1−t) + D&A − ΔWC − Capex	Net Income + D&A − ΔWC − Capex + Net Borrowing
Treatment of interest	Excluded — calculated pre-interest	Included — calculated post-interest and post-debt repayment
Discount rate used	WACC (blended cost of debt + equity)	Cost of equity (Ke) only
Output value	Enterprise Value (EV)	Equity Value directly
Bridge to equity	Equity Value = EV − Net Debt	No bridge needed — already equity value
Used in	Most DCF models, M&A valuations, ACCA AFM	Dividend discount models, equity research, CFA

⚠️ Critical Rule: Never mix FCFF with cost of equity (Ke), or FCFE with WACC. FCFF must be discounted at WACC to get Enterprise Value; FCFE must be discounted at cost of equity to get Equity Value directly. Mixing these is one of the most penalised errors in ACCA AFM exam scripts.

How to Calculate Free Cash Flow: Step-by-Step with Worked Example

Calculating free cash flow from an income statement requires five steps: start with EBIT, apply the tax rate to get NOPAT, add back depreciation, adjust for working capital changes, then deduct capital expenditure. Below is a fully worked example using both the FCFF and FCFE approach for the same company.

Company Data — TechCo Ltd (Year Ending Dec 2025)

EBIT: $50m
Tax rate: 25%
Depreciation & Amortisation: $8m
Increase in Working Capital: $3m
Capital Expenditure: $12m
Interest expense: $4m
Net borrowing (new debt raised): $2m

Step	FCFF Calculation	FCFE Calculation
1. Starting point	EBIT = $50m	Net Income = EBIT − Interest − Tax = (50 − 4) × (1 − 0.25) = $34.5m
2. Tax adjustment	NOPAT = $50m × (1 − 0.25) = $37.5m	Net Income already post-tax = $34.5m
3. Add back D&A	$37.5m + $8m = $45.5m	$34.5m + $8m = $42.5m
4. Less ΔWorking Capital	$45.5m − $3m = $42.5m	$42.5m − $3m = $39.5m
5. Less Capex	$42.5m − $12m = $30.5m	$39.5m − $12m = $27.5m
6. Add Net Borrowing (FCFE only)	N/A	$27.5m + $2m = $29.5m
Result	FCFF = $30.5m	FCFE = $29.5m

Equity Value Bridge (from FCFF): If FCFF is used in a DCF model discounted at WACC = 10% with a 5-year explicit period and 2.5% terminal growth, you arrive at an Enterprise Value. To get Equity Value: Equity Value = Enterprise Value − Net Debt. If net debt = $40m, and EV = $280m, then Equity Value = $240m. This bridge step is non-negotiable — see the DCF valuation complete guide for the full worked EV-to-equity bridge.

✅ Pro Tip: In ACCA AFM, working capital adjustments are frequently tested. An increase in working capital is a cash outflow (subtract it). A decrease in working capital is a cash inflow (add it). Getting this direction wrong is a common source of lost marks.

Common Free Cash Flow Mistakes to Avoid

The most damaging FCF errors involve either deducting interest from FCFF (which double-counts the financing cost), or forgetting to subtract net debt when bridging from Enterprise Value to Equity Value. Both errors are directly tested in ACCA AFM exam questions and appear regularly in the examiner's report as lost-mark traps.

Mistake 1 — Deducting interest from FCFF: FCFF is calculated pre-interest using NOPAT (EBIT after tax). Interest is already accounted for in the WACC discount rate. Deducting interest again from the numerator double-counts the financing cost and produces an understated FCFF. Rule: if you are using FCFF, start from EBIT — never from net income without adding interest back.
Mistake 2 — Forgetting to subtract net debt for equity value: FCFF discounted at WACC gives Enterprise Value — not Equity Value. You must subtract net debt (total debt minus cash) to arrive at Equity Value. Many candidates stop at EV and use that figure per share. This overstates equity value by the full net debt amount.
Mistake 3 — Not adding back depreciation: Depreciation is a non-cash charge already deducted from EBIT. It must be added back in the FCF calculation. Forgetting this understates FCF by the full depreciation amount each year.
Mistake 4 — Wrong working capital direction: An increase in current assets (e.g. debtors rising) uses cash — subtract it. An increase in current liabilities (e.g. creditors rising) provides cash — add it. Getting the sign wrong on working capital movements is one of the most frequent computational errors in exam conditions.
Mistake 5 — Including maintenance vs growth capex confusion: In advanced models, total Capex should be split between maintenance capex (required to sustain current operations) and growth capex (investment for expansion). Both reduce FCF, but analysts sometimes mistakenly deduct only one.
Mistake 6 — Using accounting profit instead of cash flow: Net income includes non-cash items (depreciation, amortisation, share-based payments) and accruals. Always reconcile from net income to operating cash flow before calculating FCF, or use the EBIT-based NOPAT approach to avoid this entirely.

⚠️ ACCA AFM Exam Alert: Mistake 1 (interest in FCFF) and Mistake 2 (not deducting net debt) are the two most penalised errors in ACCA AFM business valuation questions. The examiner has flagged both in multiple sitting reports. Before finalising any FCF calculation in an exam, ask: "Have I included interest in a FCFF calculation?" and "Have I subtracted net debt from EV before reporting equity value?"

How Free Cash Flow Is Used in DCF Valuation

In a discounted cash flow (DCF) model, free cash flow is the input that gets discounted — it is the engine of the entire valuation. FCFF is projected over a 5–10 year forecast period, discounted at WACC to produce Enterprise Value, which is then bridged to Equity Value by subtracting net debt.

DCF Step	Using FCFF	Using FCFE
Cash flow projected	Unlevered FCF (pre-interest)	Levered FCF (post-interest)
Discount rate applied	WACC	Cost of equity (Ke)
Output	Enterprise Value (EV)	Equity Value (direct)
Equity bridge required?	Yes — EV minus net debt	No
Best suited for	M&A, company-wide valuations, ACCA AFM	Equity-only valuations, dividend discount models

The relationship between FCF and DCF is direct: DCF is the valuation framework, and FCF is the fuel. A DCF model is only as reliable as the FCF projections that feed it. For a full worked DCF model including terminal value calculation, sensitivity tables, and M&A application, read our Discounted Cash Flow (DCF) Valuation: Complete Guide with Examples.

Free Cash Flow in ACCA AFM: What You Need to Know

In ACCA Advanced Financial Management (AFM), free cash flow is tested across multiple syllabus areas — primarily in investment appraisal (using FCF for NPV and APV), business valuation for mergers and acquisitions, and corporate reconstruction scenarios. The exam consistently tests whether candidates can correctly construct FCFF from an income statement and bridge it to equity value.

AFM Topic Area	FCF Application	Key Exam Skill
Business Valuation (M&A)	FCFF → EV → Equity Value bridge	Correctly excluding interest from FCFF
Investment Appraisal	Project FCF for NPV / APV	Adjusting for inflation (nominal vs real)
Corporate Reconstruction	FCF to value business post-restructure	Identifying synergy FCF vs standalone FCF
Dividend Policy	FCFE as basis for sustainable dividend	Distinguishing FCFF from FCFE in context

AFM candidates should be able to build FCF from scratch using only EBIT, a tax rate, depreciation, working capital movement, and capex figures provided in a scenario. Practice this calculation until it is automatic. For complete preparation guidance including past paper practice and examiner tips, see our ACCA AFM study materials and BPP online course and our guide on how to pass ACCA AFM.

📚 Next Steps

Ready to master free cash flow for ACCA AFM? Explore our ACCA AFM BPP Course and Exam Kit — the Exam Kit contains fully worked FCF and business valuation questions with examiner commentary. Also read our ACCA AFM technical articles 2026 for examiner-written guidance on free cash flow valuation.

About the Author

Vicky Sarin — CFA Charterholder | ACCA AFM Subject Matter Expert

Vicky Sarin has over 12 years of experience in corporate finance, business valuation, and professional certification training. She specialises in teaching free cash flow modelling and DCF valuation to ACCA AFM candidates, with a track record of helping students avoid the exact formula and conceptual errors that cost marks in the exam. Vicky draws on real-world M&A and investment appraisal experience to make complex financial concepts exam-ready and practically applicable.

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Reviewed by: ACCA-qualified subject expert, Eduyush Academic Team

Frequently Asked Questions

Q: What is free cash flow and why does it matter?

Free cash flow (FCF) is the cash a business generates after paying operating expenses and capital expenditures. Unlike net profit, FCF reflects actual cash — not accounting profit — making it the most reliable indicator of financial health. Investors, analysts, and valuation models use FCF to assess how much cash a business genuinely produces for distribution or reinvestment.

Q: What is the free cash flow formula?

The simplest free cash flow formula is: FCF = Operating Cash Flow − Capital Expenditures. For financial modelling and exam purposes, the EBIT-based formula is more common: FCF = EBIT × (1 − Tax Rate) + Depreciation & Amortisation − Change in Working Capital − Capital Expenditure. Both methods produce the same result when applied correctly.

Q: What is the difference between FCFF and FCFE?

Free Cash Flow to the Firm (FCFF) measures cash available to all capital providers — debt and equity — calculated before interest payments, and is discounted at WACC to produce Enterprise Value. Free Cash Flow to Equity (FCFE) measures what remains for shareholders after debt repayments, discounted at the cost of equity to give Equity Value directly. Never mix the two with the wrong discount rate.

Q: Why should you not deduct interest when calculating FCFF?

FCFF is calculated pre-interest because the cost of debt financing is already reflected in the WACC discount rate. Deducting interest expense from FCFF double-counts the financing cost — once in the cash flow numerator and once in the discount rate denominator. Always start FCFF from EBIT (or NOPAT), not from net income, unless you add interest back explicitly.

Q: How do you get from Enterprise Value to Equity Value using FCF?

When using FCFF in a DCF model, the output is Enterprise Value (EV). To arrive at Equity Value, subtract the company's net debt: Equity Value = Enterprise Value − Net Debt (where Net Debt = Total Debt − Cash). Forgetting this step is one of the most common and costly errors in ACCA AFM exam answers, as it overstates the value available to shareholders.

Q: What does negative free cash flow mean?

Negative free cash flow means a company is spending more on operations and capital investment than it generates from its core business. This is not always a red flag — high-growth companies often have negative FCF during expansion phases as they invest heavily in assets and working capital. However, sustained negative FCF without a clear path to positive cash generation indicates a funding risk.