Accounting For Dummies®, 4th Edition

6.5. Trying to Pin Down "Free Cash Flow"

A term has emerged in the lexicon of finance: free cash flow. This piece of language is not — I repeat, not — an officially defined term by any authoritative accounting rule-making body. Furthermore, the term does not appear in cash flow statements reported by businesses. Rather, free cash flow is street language, and the term appears in The Wall Street Journal and The New York Times. Securities brokers and investment analysts use the term freely (pun intended). Unfortunately, the term free cash flow hasn't settled down into one universal meaning, although most usages of the term have something to do with cash flow from operating activities.

The term free cash flow has been used to mean the following:

• Net income plus depreciation expense, plus any other expense recorded during the period that does not involve the outlay of cash — such as amortization of costs of the intangible assets of a business, and other asset write-downs that don't require cash outlay

• Cash flow from operating activities as reported in the statement of cash flows, although the very use of a different term (free cash flow) suggests a different meaning is intended

• Cash flow from operating activities minus the amount spent on capital expenditures during the year (purchases or construction of property, plant, and equipment)

• Earnings before interest, tax, depreciation, and amortization (EBITDA) — although this definition ignores the cash flow effects of changes in the short-term ...