What is the free cash flow formula?

Free cash flow = Operating cash flow − Capital expenditures. Operating cash flow is reported on the cash flow statement (under "operating activities"). Capex appears in the investing section, usually labelled "purchases of property, plant and equipment." Both are disclosed in every quarterly 10-Q and annual 10-K filed with the SEC.

Why is free cash flow different from net income?

Net income is an accounting figure; it includes non-cash charges (depreciation, amortisation, stock-based compensation) that reduce profit but move no cash, and it ignores capital expenditures, which are real cash outflows that never appear on the income statement. Free cash flow adjusts for both: it adds non-cash expenses back to arrive at operating cash flow, then subtracts the actual cash spent on equipment and infrastructure.

What is a good FCF margin?

FCF margin varies widely by industry. Asset-light software, media, and marketplace businesses can reach 20–35% or higher. Capital-intensive manufacturers, utilities, and semiconductor fabs often land in the low single digits or even negative during heavy investment cycles. The most useful benchmark is a company's own historical margin and its direct competitors — not a single universal threshold.

What is FCF yield, and how is it used?

FCF yield = Free cash flow ÷ Market capitalisation, expressed as a percentage. It answers: "What fraction of what I paid would I earn if the company returned all its free cash flow?" It is to FCF what earnings yield (1 ÷ P/E) is to net income — a valuation signal rather than a profitability one. A higher FCF yield generally suggests better value, but comparing across industries with different capex profiles can be misleading.

Does all capex reduce free cash flow equally?

In the standard formula, yes — all capex is subtracted from operating cash flow to get FCF. Some investors distinguish between maintenance capex (spending to keep existing assets running) and growth capex (spending to expand capacity). They argue only maintenance capex should reduce a "normalised" FCF. Companies rarely split the two in their filings, so this refinement usually requires management commentary or estimation.

Free cash flow explained: why it differs from net income

Free cash flow in one formula

Free cash flow (FCF) is the cash a business generates after funding the investments needed to maintain or grow it. The formula is straightforward: FCF = Operating cash flow − Capital expenditures.

Operating cash flow captures the cash the core business actually produced — before the company spent any of it on equipment, buildings, or infrastructure. Capital expenditures (capex) is that spending. The difference is what is left over for dividends, share buybacks, debt repayment, or acquisitions.

Both inputs come from the cash flow statement in every quarterly and annual SEC filing — operating cash flow from the “operating activities” section, and capex from the “investing activities” section, typically labelled “purchases of property, plant and equipment.”

Why net income is not cash

Net income and free cash flow can differ significantly, even for a healthy business. Four mechanisms explain most of the gap.

Depreciation and amortisation (D&A)

D&A is a non-cash expense that reduces net income each quarter, but no money leaves the company when it is recorded — the cash left when the asset was originally purchased. D&A is added back when moving from net income to operating cash flow on the cash flow statement.

Stock-based compensation (SBC)

Paying employees in shares costs the company equity, not cash, so SBC reduces net income without reducing the cash balance. Like D&A, it is added back on the cash flow statement. For technology companies with large equity programmes, SBC can be a multi-billion-dollar wedge between profit and cash flow.

Capital expenditures

When a company buys equipment or builds a factory, the cash goes out immediately — but only the annual depreciation of that asset appears on the income statement over many years. Net income misses the full cash cost; FCF captures it by subtracting capex in one step.

Working capital changes

Rapid revenue growth often requires more cash to be tied up in receivables and inventory. A company can record rising net income while simultaneously consuming cash to fund the growth. The cash flow statement captures this as a working-capital drag on operating cash flow.

These four factors — D&A, SBC, capex, and working capital — explain why a company can report strong net income while generating modest cash, or vice versa. FCF cuts through all of it.

FCF margin and how to use it

FCF margin = Free cash flow ÷ Revenue. It measures what fraction of every dollar of revenue converts into freely deployable cash. Where net margin tells you what the accounting rules say you earned, FCF margin tells you what arrived in the bank.

FCF margin is most useful for:

Peer comparison. Two companies with the same net margin may convert very differently to cash if one is more capital-intensive.
Trend analysis. A margin that shrinks as revenue grows can signal capex or working-capital absorption that will eventually catch up with the business model.
Validating net margin. A company with persistently higher FCF margin than net margin is doing something right; one where FCF consistently lags net income bears closer examination.

A real example: Apple FY2023

Apple's fiscal year 2023 (ended 30 September 2023) illustrates what strong free cash flow generation looks like for a mature, asset-light consumer technology business.

Apple Inc. — FCF calculation, FY2023

Revenue

$383.3B

Net income

Net margin ≈ 25%

$97.0B

Operating cash flow

Includes non-cash add-backs: D&A, SBC, working capital

$110.5B

− Capital expenditures

Purchases of property, plant and equipment

$10.9B

Free cash flow

FCF margin ≈ 26% — slightly above net margin

$99.6B

Source: Apple Inc. — Annual Report on Form 10-K for the fiscal year ended September 30, 2023 (filed with the SEC, 3 November 2023). Figures from the Consolidated Statements of Cash Flows; rounded to $0.1B.

Notice that FCF ($99.6B) is actually higher than net income ($97.0B). That is because D&A and SBC add-backs more than offset the capex subtraction — Apple spends relatively little on physical infrastructure compared to its earnings power. A capital-intensive manufacturer would show the opposite: FCF well below net income because capex outweighs non-cash add-backs.

Frequently asked questions

Earnings Season: Revenue vs EPS — Which One Matters? — includes a full income-statement-to-FCF bridge showing how each line connects.
Profit margin explained — gross, operating, and net margins; FCF margin extends the cascade one step further.
Rule of 40 explained — the standard SaaS composite metric uses FCF margin as its profitability input.
Earnings per share (EPS) explained — the accounting profit that FCF adjusts and extends.
Earnings Season course — seven lessons on how to read a real earnings report from headline numbers to guidance.