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How free cash flow is built

Unlevered free cash flow is NOPAT plus D&A, minus capex, minus the increase in net working capital. On $100,000,000 of EBIT, 25 percent tax, $20,000,000 of D&A, $30,000,000 of capex and a $10,000,000 working-capital increase, free cash flow is $55,000,000.

Unlevered free cash flow

$55,000,000

NOPAT is $75,000,000.

EBIT
$100,000,000
Tax
$25,000,000
NOPAT
$75,000,000
D&A
$20,000,000
Capex
$30,000,000
Change in NWC
$10,000,000
Free cash flow
$55,000,000
$

Figures on this page are in millions of dollars.

%
$
$
$

A rise uses cash. A fall (negative here) is a source of cash.

On this page

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FCF yield

In short

  • NOPAT is EBIT after tax. On $100,000,000 of EBIT at 25 percent, tax is $25,000,000 and NOPAT is $75,000,000.
  • Add $20,000,000 of D&A, subtract $30,000,000 of capex, subtract a $10,000,000 working-capital increase: FCF is $55,000,000. EBITDA is $120,000,000, which is not cash.
  • A working-capital fall is a source of cash. Flip the delta from a $10,000,000 use to a release and FCF rises to $70,000,000. NOPAT did not change.
  • Raise capex to $50,000,000 on the first sheet and FCF falls to $35,000,000. Profit did not fall. The cash spent on assets did.
  • This is free cash flow to the firm, before interest. A DCF of this number is an enterprise-value DCF. How DCF works is that model.

The five-line teaching bridge

Free cash flow on this page is unlevered, cash from the operations as if they were all-equity financed:

FCF=EBIT(1−t)+DA−Capex−ΔNWCFCF = EBIT(1-t) + DA - \text{Capex} - \Delta NWC

On $100,000,000 of EBIT at 25 percent tax, tax is $25,000,000 and NOPAT is $75,000,000. Add back $20,000,000 of D&A (a non-cash charge), subtract $30,000,000 of capex (the cash that bought assets), subtract a $10,000,000 increase in working capital. FCF is $55,000,000.

EBITDA is EBIT plus D&A, $120,000,000. That is not cash. It has not yet paid tax, capex, or the working-capital drain.

The free cash flow calculator on this page is those five lines. How DCF works discounts a series of them. How enterprise value works is the stock identity a DCF of this FCF is trying to explain.

Working capital can reverse the sign

Keep EBIT, tax, D&A and capex on the first sheet. Let net working capital fall, so the delta is a release rather than a $10,000,000 use. FCF is $70,000,000.

NOPAT is still $75,000,000. The working-capital line flipped from a subtract to an add. That is a one-time source unless the firm can keep shrinking working capital every year, which it cannot. Growth usually does the opposite: more receivables and inventory than payables, a use of cash, which is why a profitable year can still print thin FCF.

Capex is the other lever

Back to a $10,000,000 working-capital increase. Raise capex to $50,000,000. FCF is $35,000,000. NOPAT is still $75,000,000.

Adding D&A back and then subtracting capex is how the bridge avoids double-counting the asset: D&A is the accounting allocation of an old purchase, capex is the cash this period. Heavy capex on a growing firm is why FCF can sit well below NOPAT without the operations having failed.

EBITDA against free cash flow is that skip as a table. On this sheet EBITDA is $120,000,000 and unlevered free cash flow is $55,000,000. One has not paid tax, capex or working capital. The other has.

What this page is not doing

It is not free cash flow to equity (interest and net borrowing are not taken off), not a full cash-flow statement, and not a forecast. The three sheets are $55,000,000 of FCF on the teaching bridge, $70,000,000 when working capital is a source, and $35,000,000 when capex is $50,000,000. This is educational material, not financial advice.

Worked examples

The five-line teaching sheet

EBIT is $100,000,000, the tax rate is 25 percent, D&A is $20,000,000, capex is $30,000,000, and net working capital rises by $10,000,000. What is unlevered free cash flow?

  1. Tax on EBIT: 0.25×100000000=250000000.25 \times 100000000 = 25000000, so $25,000,000.
  2. NOPAT: 100000000−25000000=75000000100000000 - 25000000 = 75000000, so $75,000,000. The same figure as 100000000×(1−0.25)100000000 \times (1 - 0.25).
  3. Add back D&A, subtract capex, subtract the working-capital increase: 75000000+20000000−30000000−10000000=5500000075000000 + 20000000 - 30000000 - 10000000 = 55000000, so $55,000,000.
  4. EBITDA is EBIT plus D&A: 100000000+20000000=120000000100000000 + 20000000 = 120000000, so $120,000,000. That is not cash.

NOPAT is $75,000,000. Unlevered free cash flow is $55,000,000.

Working capital as a source of cash

Keep EBIT at $100,000,000, tax at 25 percent, D&A at $20,000,000 and capex at $30,000,000. Net working capital falls, so the delta is -5000000. What is FCF?

  1. NOPAT is still $75,000,000. Tax is still $25,000,000.
  2. The working-capital line is now added, not subtracted: 75000000+20000000−30000000−(−5000000)=7000000075000000 + 20000000 - 30000000 - (-5000000) = 70000000, so $70,000,000.

Free cash flow is $70,000,000. NOPAT did not change. The working-capital release did.

Heavier capex on the same NOPAT

Back to a $10,000,000 working-capital increase. Capex is now $50,000,000. EBIT, tax and D&A are the first sheet. What is FCF?

  1. NOPAT is still $75,000,000.
  2. FCF: 75000000+20000000−50000000−10000000=3500000075000000 + 20000000 - 50000000 - 10000000 = 35000000, so $35,000,000.

Free cash flow is $35,000,000. Capex of $50,000,000, not a change in profit, is what moved the answer.

Common questions

Is this free cash flow to equity?

No. This is free cash flow to the firm: operations, after tax as if unlevered, before interest. Free cash flow to equity would take interest and net borrowing off. A DCF of the $55,000,000 on the first sheet is an enterprise-value DCF.

Why add depreciation back?

Because it reduced EBIT without spending cash this period. The cash that bought the asset is capex, on its own line. On the first sheet, $20,000,000 of D&A is added back and $30,000,000 of capex is subtracted. Those are different years of the same kind of spending.

What if working capital falls?

Then the delta is negative and FCF rises, which is the second sheet: $70,000,000 rather than $55,000,000. It is a one-time source unless the firm can keep shrinking working capital every year.

Keep reading

This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.