The cash a business generates after paying for capital expenditures. Warren Buffett considers this the most important number for valuing a business because it represents money that can actually be returned to shareholders or reinvested in growth.
Formula
Description
The cash a business generates after accounting for capital expenditures needed to maintain or expand its asset base. Warren Buffett calls this "owner earnings" and considers it the most important number for valuing a business. FCF represents money that can be returned to shareholders through dividends and buybacks or used for acquisitions and debt paydown.
Interpretation
Positive and growing FCF is essential for sustainable shareholder returns. Negative FCF in a mature company is a red flag. Compare FCF to net income: FCF consistently above net income signals high-quality earnings. FCF below net income over multiple years suggests aggressive accounting or heavy reinvestment needs.
Related Quality Indicators
The percentage of revenue left after paying all operating expenses but before interest and taxes. This shows how efficiently the core business runs. Above 15% is generally strong. Consistently expanding margins signal improving business quality.
The percentage of every revenue dollar that becomes bottom-line profit after all expenses. Above 10% is strong for most industries. Persistently high net margins often indicate a company has a competitive moat protecting its business.
Profitability before the effects of debt, taxes, and depreciation. Useful for comparing companies across different tax jurisdictions and capital structures. Above 20% is generally strong. Often used in merger and acquisition analysis.
The percentage of revenue that converts to free cash flow. This is arguably the most honest profitability metric because free cash flow is difficult to manipulate. Above 10% is strong. Capital-light businesses like software companies tend to have the highest FCF margins.
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