The difference between cash flow and free cash flow
/What is Cash Flow?
Cash flow is the movement of cash into and out of a business during a reporting period. Cash inflows may arise from customer payments, borrowing, investments, or asset sales, while outflows include payroll, supplier payments, debt service, taxes, and asset purchases. Cash flow analysis helps management assess liquidity, fund operations, meet obligations, plan investments, and determine whether the organization can sustain its activities without additional financing.
What is Free Cash Flow?
Free cash flow is the cash a business generates after paying operating expenses and making necessary capital expenditures. It indicates how much cash remains available to repay debt, distribute dividends, repurchase shares, acquire other businesses, or build reserves. Analysts use free cash flow to assess financial flexibility, valuation, and the sustainability of earnings, since strong accounting profits do not always produce sufficient usable cash for investors.
Comparing Cash Flow and Free Cash Flow
There are several differences between cash flow and free cash flow, which are as follows:
Representation of condition. Of the two concepts, free cash flow is the more refined measure, because it is a strong indicator of the ability of an entity to remain in business, including expenditures to support operations and pay for ongoing fixed asset enhancements.
Purpose. Cash flow measures overall cash inflows and outflows, while free cash flow indicates how much cash is available for debt repayment, dividends, or reinvestment after covering essential expenses.
Reporting. Cash flow is reported on a company’s statement of cash flows, whereas there is no such reporting of free cash flows - it must be derived from other information sources, and then presented in a separate report.
Cash Flow and Free Cash Flow FAQs
Are both cash flow and free cash flow required for financial reporting?
Cash flow reporting is required because GAAP and IFRS mandate a formal statement of cash flows as part of the financial statements. Free cash flow, however, is not required and is considered a non-GAAP metric that companies may choose to disclose. As a result, free cash flow is used mainly for analysis rather than regulatory reporting.