Free Cash Flow (FCF) Explained
OCF minus capex — the number DCF models actually forecast.
What is free cash flow?
Free Cash Flow = Operating Cash Flow − Capital Expenditures. It's the cash a business generates after maintaining and expanding its asset base. Unlike net income, FCF is hard to manipulate with accounting choices, making it the preferred input for DCF models.
Why not use net income?
Net income includes non-cash items (depreciation, amortization, stock-based comp) and can be distorted by accounting elections. FCF reflects actual cash the business produces — cash that can be returned to shareholders, used to pay debt, or reinvested. 'Cash is fact, profit is opinion.'
FCF vs. FCFF vs. FCFE
Free Cash Flow to the Firm (FCFF) is pre-debt-service — used in enterprise DCFs discounted at WACC. Free Cash Flow to Equity (FCFE) is post-debt-service — used in equity DCFs discounted at cost of equity. Most public company DCFs use FCFF.