Free cash flow is a measure of a company’s financial health and is part of its cash flow statement. It is defined as earnings before interest, taxes, depreciation, and amortization (EBITDA) minus taxes paid, capital expenditures, dividends paid, and any changes to working capital. Free cash flow represents the amount of cash the company generates after paying all of its bill and reinvesting back into itself. Companies with significant positive free cash flow retain greater flexibility as they are able to make additional investments in the business, pay down debt, and increase shareholder payouts. A negative free cash flow could indicate a company is having difficulty in paying all of its bills, but is not necessarily indicative of financial trouble. Companies with negative cash flow positions could also simply be making large investments in their businesses or issuing special dividends to shareholders. Free cash flow can potentially be a better measure of a business’ health than other financial statement measures as it’s less prone to accounting adjustments. Earnings, for example, can be manipulated if a company accelerates revenue recognition, spreads out expenses over time, or incurs special one-time charges. Cash flow is a more direct measure of how money is moving into and out of the business.
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