Difference between Cash Flow and Free Cash Flow

Abstract:

Each business entity, regardless of its size, capital structure, and nature, needs cash for maintaining the business easily. Without any adequate money, the business will most likely be unable to satisfy long-term and transient commitments, which could prompt the end of the business. The development of money can be of two kinds, i.e. free cash flow and cash flow. Cash flow alludes to the inflow and outflow of money to/from the association.

Unlikely against the norm, free cash flow, as the name proposes, is the money accessible to the business entity. There are numerous individuals who don’t comprehend the terms plainly and wind up comparing the two.

The contrast between free cash flow and cash flow is disorder and chaos. Cash flow is utilised to ascertain how much money comes into a business and how much money goes out towards the end of an accounting period. Free cash flow is utilised to figure out the valuation of the organisation through a Discounted Cash Flow (DCF) strategy.

Cash flow is a lot more extensive concept-wise. Also, free cash flow is determined by utilising earnings before interest and taxes.

As a financial backer, one must really know them both. Cash flow will assist one with seeing the genuine image of an association. However, free cash flow will assist one with tracking down the worth of the stock (or the business) by utilising the DCF strategy for valuation.

Meaning of Cash Flow:

The inflow and outflow of money in a specific monetary year bring about the increment or decline in the money position of the organisation is known as cash flow. It emerges because of the exercises and activities of the business, such as working, contributing, and funding exercises. More or less, the distinction between cash towards the start and the finish of the monetary year is viewed as cash for that accounting year.

Here, working or operating activities add up to the everyday business exercises like sales or acquisition of products, payments made to leasers, providers, or representatives, receipts from debtors, and so forth. Investing activities represent the purchase or sale of an investment or an asset. Funding activities add up to represent the issue of shares and debentures or redemption of shares and debentures, payment of profits, and so on.

The cash flow statement is perhaps the main statement the financial backer ought to go through before they at any point purchase the shares of an organisation. In the income statement, there’s a chance to straighten or flatten the benefit for the year. However, in the cash flow statement, it’s really difficult to control the numbers.

That is the reason, as a financial backer, one’s expected level of effort isn’t finished except if one takes a look at the cash flow statement first.

There are two different ways through which you can compute the net cash flow of the business entity – the direct method and the indirect method. The main distinction between indirect and direct techniques is the estimation of operating activities or exercises.

Meaning of Free Cash Flow:

The real money accessible to the organisation, for circulation to its security holders, is known as free cash flow. A positive free cash flow uncovers that the organisation is creating sufficient money to run the business proficiently. In any case, the negative free cash flow shows that the organisation can’t create adequate money, or it has put away cash elsewhere which will produce significant yields from this point forward.

There are a few strategies for the computation of an organisation’s free cash flow, yet one famous technique is given as under:

Free Cash Flow = EBIT + Depreciation and Amortisation – ( WC Changes + CAPEX)

Here,

FCF = Free Cash Flow

EBIT = Earnings Before Interest and Taxes

WC Changes = Working Capital Changes

Capex = Capital Expenditure.

Difference between Cash Flow and Free Cash Flow:

CASH FLOW

FREE CASH FLOW

Meaning

Cash flow ascertains the net money inflow of working, financing, and investing exercises of the business.

Free cash flow is utilised to ascertain the current worth of the business.

Purpose

The primary goal is to figure out the real net money inflow of the business.

The principle objective is to figure out the valuation of a business for financial backers.

Range

The scope of cash flow is a lot more extensive.

The extent of free cash flow is restricted.

Formula

Cash Flow = Cash flow from (Operating activities + Investing Activities + Financing Activities).

Free Cash Flow = EBIT * (1 – Tax Rate) + Depreciation – Capital Expenditure – Increase in Net Working Capital / (+) Decrease in Net Working Capital

Difficulty

The arrangement of cash flow gets intricate when multiple money and non-cash exchanges happen during a year.

The arrangement of free cash flow becomes complicated when one needs to compute everything prior to applying the equation.

Consumption of Time

Cash flow invests in the time to plan.

On the off chance that all the data is accessible, FCF doesn’t invest in the time to ascertain.

Important Concepts

Working Cash Flow, Investing Cash Flow, and Financing Cash Flow

EBIT, Capital Expenditure, and Increase/decline in net working capital.

Utilisation

Cash flow is one of the most significant fiscal reports in monetary bookkeeping.

Free Cash Flow is utilised to work out the valuation under the DCF Method.

Origin

To make a cash flow analysis, an income statement is required.

To ascertain free cash flow, the income statement is also expected.

Conclusion:

Free cash flow and cash flow might seem like comparable ideas; however, they are totally unique.

The essential distinction is the manner in which they’re utilised. Cash flow is utilised to look at the feasibility of a business. Free cash flow is utilised to figure out the valuation of a business prior to contributing.

As a financial backer, one really must look into both these types of cash flows and have a comprehensive image of the business.

Also, see:

Income and Expenditure Account Based on Trial Balance

Issue of Debentures as a Collateral Security

Computerised Accounting System

Balance Sheet of a Fictional Bank

Market Equilibrium Free Entry and Exit

Market Equilibrium Fixed Number of Firms

Income Statement Everything You Need to Know

Adjustment for Revaluation of Assets and Liabilities

Leave a Comment

Your Mobile number and Email id will not be published. Required fields are marked *

*

*