Free cash flow is a pure measure of the cash a company has left once it has met all its operating obligations. To get it, you subtract a firm’s non-discretionary costs such as capital expenditure from its operating cash flow.
As a rule of thumb, a genuinely healthy company will tend to show positive free cash flow every year. It is free cash flow that allows a company to buy back shares, increase dividends, negotiate acquisitions, pay off debt and upgrade its equipment.
The free cash flow yield is worked out by dividing free cash flow per share by market capitalisation and total debt. The resulting percentage is a useful way of comparing companies that operate in the same market. The higher the firm’s free cash-flow yield, the better.
• See Tim Bennett’s video tutorial: Five ways companies can cook cash flow.