Free cash flow: what is left for the owner

Free cash flow is the money a company has left after it has paid for its day-to-day operations, its taxes and the investment in its own assets. It is out of this remainder that a dividend is physically paid, debt is repaid and the company's own shares are bought back; the profit shown in the income statement has no such ability, because it is built from accruals, revaluations and non-cash items. What the owner receives is not profit but cash flow — and the gap between them can persist for years.

Where the figure comes from: the sections of the cash flow statement

The cash flow statement is divided according to the nature of the transactions. Operating cash flow shows how much money the core business brought in after taxes and changes in working capital. Investing cash flow gathers the purchase and sale of assets. Financing cash flow reflects the relationship with creditors and shareholders: the raising and repayment of debt, and payments to the owners.

Free cash flow is calculated from operating cash flow less capital expenditure — the investment without which production would stop or fail to grow. Technically the subtraction is simple; in substance the whole argument is about which expenses exactly should count as capital expenditure and over what period they should be averaged. The definitions in the site's own wording are collected under free cash flow and in the glossary.

Which "free" exactly: cash flow to the firm and cash flow to equity

Different quantities hide behind the same name, and confusing them changes the conclusion.

Free cash flow to the firm is the remainder before settlements with creditors. It belongs to all providers of capital at once and is used where the business is valued as a whole, regardless of the structure of its debt.

Free cash flow to equity is the remainder after interest and after repayment of the debt principal, adjusted for new borrowing. This is what is actually available to the holder of an ordinary share. At a heavily indebted company, cash flow to the firm may look healthy while cash flow to equity is wiped out by the repayment schedule.

Why profit and cash flow diverge

Depreciation reduces profit but takes no money away — the money was already spent in the year the asset was bought. The other side of the coin: a company with a worn-out equipment fleet reports a profit, while its cash flow is eaten up by repairs and the replacement of fixed assets.

Working capital acts like a pump. Growth in inventories and receivables as revenue rises ties up cash, and a profitable year delivers weak cash flow. A shrinking business gives the opposite picture: cash is released even though things are going worse. How stable the relationship is can be seen from cash conversion — the profit-to-cash conversion ratio, which is worth looking at over several years rather than over a quarter.

A separate source of divergence is the capitalisation of expenses. Costs assigned to an asset instead of to the current period lift profit and move to the investing section, which means they are deducted from free cash flow. Profit and cash flow diverge by exactly the amount of that accounting policy decision.

What distorts the picture in Russian financial statements

Capital expenditure is rarely split into maintenance and expansion spending. To assess the sustainable remainder it is the maintenance figure that is needed, but not all issuers disclose it, and some companies give the split only in presentations, not in the statements.

A non-recurring sale of an asset lifts the investing section and creates a non-recurring free cash flow that is easily mistaken for a working characteristic of the business. The same applies to loans to related parties and to the movement of money inside a holding: at the parent company, cash flow is formed by dividends from subsidiaries, and its timing depends on decisions taken at the level of those entities, not on sales.

After the change in accounting standards, leases moved part of the payments from the operating section to the financing section. Operating cash flow looks better as a result, although the liability has remained. Cash flow before and after the transition cannot be compared without an adjustment.

Such things have to be checked against the primary source — the issuer financial statements section.

The link to the dividend

The dividend policies of many Russian issuers are tied precisely to free cash flow rather than to profit, and often with a condition on leverage. That makes cash flow a direct predictor of the payout, but not a guarantee: the board of directors may direct the remainder to debt repayment, a share buyback or the investment programme. Cash flow shows the ability to pay; the decision to pay is a separate event.

Declared payouts and dates are convenient to check in the calendar: {{dividend_calendar|limit=5}}. The full list is kept in the dividends section.

The relationship with earnings-based multiples shows where profit and cash part ways. As an example, the card {{instrument:SBER}} and its metric 3,77 rest on profit; a comparison with cash flow gives a different picture and often a different ranking of companies in the sector comparison on the stocks page.

How to read cash flow over the cycle

Free cash flow for a single year says almost nothing about a company with an investment programme: in the construction years it collapses, in the payback years it soars. The figure is therefore normalised — operating cash flow and capital expenditure are averaged over a period that covers the investment phase, and the years with non-recurring items are flagged separately.

The order of analysis:

• Step 1. Take operating cash flow from the statements, not from a presentation, and check whether it includes interest and lease payments.
• Step 2. Subtract capital expenditure, separating maintenance from expansion spending as far as the disclosure allows.
• Step 3. Exclude non-recurring proceeds from asset sales and intra-group loans.
• Step 4. Move down from cash flow to the firm to cash flow to equity, taking the debt repayment schedule into account.
• Step 5. Check the result against the declared dividend policy and the debt covenant written into it.

The site does not insert a single metric code for free cash flow: issuers' methodologies differ, and a correct figure can only be obtained by recalculating it from the specific set of statements. Cash settlements and their terminology are clarified under cash settlement; related definitions are in the glossary.