Financial analysis : Question 5
What is the exact definition of Free Cash Flow? Should dividends be deducted or not?

Free cash flow corresponds to cash generated by operations after expenditure needed to ensure that the company maintains or improves its production facilities. It is thus the cash flows that the company has at its disposal, once all necessary investments have been made, to do with as it wishes – pay back debts, pay out an exceptional dividend or not, buy back its own shares, invest in diversification, increase the size of its kitty, etc.

Free cash flows are used for two purposes: measuring a company’s room for financial manoeuvre and calculating its value by discounting the free cash flows. It is calculated as follows:
- Change in working capital
- Corporate Income tax
- Net capital expenditure

Dividends are not deducted from free cash flows because a dividend payout is one of the things free cash flows can be used for.

For more information, see chapters 29 and 32 of the Vernimmen.