What is free cash flow?
Operating cash flow left after the capital spending needed to keep running. A regional HVAC shop reads it as cash that is actually free to use.
Definition
Free cash flow is the cash left from day-to-day operations after you subtract the capital spending needed to keep the business running. On the books, this is a computed figure, not a printed GAAP line on the Statement of Cash Flows.
A regional HVAC shop reads it as operating cash minus the van, lift, or tool buy that keeps trucks on the road. It is not the leftover on the Income Statement, and it is not cash on hand at a glance.
It is a metric, not a ledger account you debit. Someone takes operating cash for the period and subtracts capital expenditures, then stops.
Accrual profit can sit ahead of this number when customers have not paid or a truck was bought with cash. This figure is only the cash that remains after those two moves.
Where it shows up
Cash flow: Related to operating cash minus capital spending, not a GAAP line.
P&L: Related to profit, which can be high while this number is low.
Balance Sheet: Related to cash and fixed assets moving.
See also: Cash Flow From Operations · Capital Expenditures · Cash Runway
When you look at your Statement of Cash Flows, you will not find a printed row with this name. You build it from the operating block minus the capital spending in the investing block.
When the figure is high, the shop's day-to-day work more than covered the equipment it had to buy. When it is low or negative, collections were thin, or a truck or lift used the cash operations just brought in.
The Balance Sheet shows cash going down and fixed assets going up when that van is bought. This metric is the cash story of those two moves together.
The Income Statement leftover is not this number. A profitable month can still leave little free cash if the shop paid cash for a truck.
How it works
Start with cash from running the shop. Subtract the cash spent to buy or improve long-lived assets that keep the work going.
The usual formula is operating cash minus capital expenditures. A shop that spent $10,000 on a van against $28,000 of operating cash has $18,000 of free cash flow.
Stay with that leftover when you read the number. Do not turn the page into a full rulebook for what counts as a capital buy.
Do not treat net income as this figure. Profit can be healthy while free cash is smaller, because a customer has not paid or a truck was purchased.
A loan draw is not added here. Financing cash can refill the bank, but this metric asks what operations left after the needed asset spend.
Depreciation expense already sits inside the bridge from profit to operating cash. You do not subtract it again when you compute this leftover.
After the month closes, the next period starts the count again. Last month's van buy does not keep reducing this month's figure.
Example
Ridge Air HVAC posts $28,000 of operating cash in May. The shop also pays $10,000 cash for a used service van that will run calls for years.
Subtract the van: $28,000 minus $10,000 is $18,000. That $18,000 is free cash flow for May.
The $18,000 is what is left after the capital spend needed to keep running. It is not the $28,000 operating block, and it is not May's profit.
If the van had been leased instead of bought, capital spending would have been $0 on this simple read. Free cash flow would have been the full $28,000 of operating cash.
If a school-district invoice had stayed unpaid, operating cash would have been lower. This leftover would have moved with it, even if May's profit stayed the same.
Common mix-ups
Free cash flow is not net income. Net income is the leftover after every expense; this figure is operating cash minus capital spending.
Free cash flow is not operating cash. Operating cash is the starting piece; this figure subtracts the equipment spend that keeps the shop running.
Free cash flow is not a GAAP line. You compute it from the Statement of Cash Flows; the statement does not print it for you.
Related terms
- Cash Flow From Operations: Cash generated or used by the day-to-day running of the business.
- Capital Expenditures: Spending to buy or improve long-lived assets.
- Cash Flow From Investing: Cash spent on or received from long-term assets.
- Cash Runway: How many months current cash will last at the present burn rate.
- Distributions: Payments of profit out to owners or shareholders.
- Debt Service Coverage Ratio: Cash available to cover scheduled principal and interest payments.
- Net Change In Cash: The total increase or decrease in cash across all three cash-flow sections.
- Cash Burn: The net cash consumed by the business over a period.