What is free cash flow?

Free cash flow (FCF) is the cash your business has left after paying its running costs and investing in long-term assets. In Bahasa Indonesia, it’s called arus kas bebas.

Think of it like your monthly take-home pay after rent and a planned motorbike purchase: whatever remains is yours to save or spend. For a business, those commitments are day-to-day operating costs plus capital expenditure (CapEx) on items such as equipment or vehicles.

Your business can look profitable on paper while much of that profit sits in unpaid invoices or unsold stock. Free cash flow shows the cash you can actually use to repay debt, build a safety buffer, reward owners or fund growth. That makes it a practical bridge between your income statement and your bank balance.

Why free cash flow matters

Free cash flow gives you, your lender and any investors a realistic view of how much cash your business can spare. Revenue and profit show how sales are going, while FCF shows whether cash remains once the bills and investments are paid.

Here’s what tracking FCF helps you do.

See how much you can put towards growth or loan repayments
Plan ahead by spotting cash shortfalls before they arrive
Show lenders and investors that your business can comfortably repay new debt
Decide whether now is the right time to hire or buy equipment

To forecast your cash from month to month before you commit, try the Xero cash flow calculator.

Free cash flow formula

The core formula for free cash flow is short. According to the Corporate Finance Institute (CFI), the generic version is cash from operations minus capital expenditure.

Free cash flow = operating cash flow – capital expenditure

Operating cash flow (OCF) is the cash your business brings in from regular trading, such as customer payments, less what you pay suppliers and staff. You’ll find it in the operating activities section of your cash flow statement.

Capital expenditure is money spent on long-term assets your business needs to run or grow, such as a delivery van or a shop renovation. Subtract CapEx from OCF and you’re left with cash that’s free for you to decide how to use.

How to calculate free cash flow

Once your financial records are up to date, you can calculate free cash flow in four steps. Each step builds on the one before.

1. Locate your operating cash flow

Start with your cash flow statement and find the total for cash flows from operating activities. This figure starts with net profit, then adjusts for non-cash costs such as depreciation and for changes in working capital.

In Indonesia, cash flow statements follow a national standard. It’s Pernyataan Standar Akuntansi Keuangan (PSAK) 207, renumbered from PSAK 2 and effective from 1 January 2024, according to Ikatan Akuntan Indonesia (IAI). PSAK 207 sorts cash flows into operating, investing and financing activities.

Micro, small and medium businesses can report under Standar Akuntansi Keuangan Entitas Mikro, Kecil, dan Menengah (SAK EMKM). Binus University’s accounting department notes that SAK EMKM leaves out the cash flow statement because it’s considered too complex for smaller businesses. If that’s you, you can build the figures from your bank records and income statement.

2. Identify your capital expenditure

Next, find your capital expenditure in the investing activities section of your cash flow statement. It covers purchases of property, equipment, vehicles and other long-term assets. If you use Xero, you can pull these figures straight from your financial reports.

3. Subtract capital expenditure from operating cash flow

Take your operating cash flow and subtract your capital expenditure, using the same period for both figures. The result is your free cash flow for the period you’re analysing.

4. Compare results across periods

One FCF figure is a snapshot, so track it monthly or quarterly to see the trend. Comparing periods reveals seasonal patterns and early signs of cash pressure.

Other ways to calculate free cash flow

Business valuations often start from earnings before interest and taxes (EBIT) rather than operating cash flow. This method gives you unlevered free cash flow, which is the cash available before any interest or loan repayments.

Unlevered free cash flow = EBIT × (1 – tax rate) + depreciation and amortisation – CapEx – change in net working capital

Multiplying EBIT by (1 – tax rate) gives you operating profit after tax. You then add back non-cash costs and subtract what you’ve invested in assets and working capital.

This measure is also called free cash flow to the firm (FCFF). CFI’s breakdown of FCFF shows you can reach it from net profit too.

Because unlevered FCF sits apart from how a business is financed, it lets you compare businesses with different levels of debt. For everyday decisions, the operating cash flow method is usually enough.

Free cash flow calculation example

Here’s how the formula works with hypothetical figures. Imagine you run a catering business in Jakarta that supplies office lunches and wedding events.

At the end of the quarter, your cash flow statement shows operating cash flow of Rp850 million. You spent Rp200 million on capital expenditure for new commercial ovens and a delivery van.

Free cash flow = Rp850 million – Rp200 million = Rp650 million

Your business generated Rp650 million in cash that quarter after covering running costs and new equipment. You could use it to repay a loan or build an emergency fund.

Next quarter, operating cash flow drops to Rp600 million and you spend Rp350 million on a refrigerated truck.

Free cash flow = Rp600 million – Rp350 million = Rp250 million

The lower figure reflects a planned investment, so it’s an expected result for that quarter. It also tells you there’s less room for discretionary spending until the truck starts earning its keep.

How free cash flow compares to other financial metrics

Free cash flow is one of several measures of business health, and each captures something different. Here’s how it relates to the metrics you’re most likely to use.

Cash flow covers all cash moving in and out of your business, while FCF focuses on what’s left from operations after CapEx
Working capital compares current assets with current liabilities at one point in time, while FCF measures cash generated over a period
Net profit includes non-cash costs and accounting estimates, while FCF shows the actual cash your business produced
Liquidity describes how easily you can turn assets into cash, while FCF is one measure that contributes to it
EBITDA (earnings before interest, taxes, depreciation and amortisation) leaves out CapEx, working capital changes, tax and interest, while FCF includes them

Each metric answers a different question about your business. Tracking FCF alongside your profit and balance sheet figures gives you a fuller picture.

Types of free cash flow

There are two main types of free cash flow. Each one answers a different question about who the cash is available to.

Free cash flow to the firm (FCFF) is the unlevered measure from the EBIT method. It’s the cash available to everyone with a financial stake in your business, including lenders and owners.

Free cash flow to equity (FCFE) is the cash available to shareholders after capital expenditure and debt movements, as CFI’s FCFE guide explains. It’s also known as levered free cash flow.

FCFE = operating cash flow – CapEx + net borrowing

Net borrowing is new debt taken on less debt repaid in the period. For most small businesses, the standard formula works for everyday decisions, while FCFF and FCFE matter more when you seek investment or prepare to sell.

Free cash flow ratios

Ratios turn free cash flow into a percentage, so you can compare it across periods or with similar businesses. Two ratios put FCF in context: FCF margin and FCF yield.

FCF margin shows how much of each rupiah of revenue becomes free cash, as Wall Street Prep explains.

FCF margin = FCF ÷ revenue

FCF yield compares free cash flow with a company’s market value, according to CFI’s FCF yield guide.

FCF yield = FCF ÷ market capitalisation

Because it needs a share price, FCF yield mainly applies to listed companies, such as those on the Indonesia Stock Exchange. Healthy levels of both ratios vary by industry and growth stage, so compare your results with your own history first.

How to interpret free cash flow

Your FCF number becomes useful once you read it in context. Here’s how to make sense of what you see.

Positive free cash flow means your business generates more cash than it spends on operations and investment. It gives you room to save or reduce debt, and several positive quarters in a row signal a stable business.

Negative free cash flow often follows a large, planned investment, such as fitting out a second location. The question is whether it’s a one-off or a pattern. Ongoing negative FCF with no clear reason suggests you’re spending more cash than you bring in.

Trends tell you more than a single figure, so review at least four quarters together. A steady rise shows improving cash generation, while a decline is a prompt to check costs and collections.

Free cash flow is the cash available to repay loans or reward owners. That’s why it matters when you apply for finance or put a value on your business.

External conditions also shape your numbers. A dip during a slow season or weaker market may reflect conditions outside your control. Read your figures alongside what’s happening in your industry.

How to improve free cash flow

You can strengthen free cash flow by bringing cash in sooner and spending it more carefully. These practical steps are a good place to start.

Send invoices as soon as the work is done, using online invoicing to track who has paid
Follow up overdue accounts receivable early and consider offering early payment discounts
Ask suppliers for longer payment terms so cash stays in your account longer
Review subscriptions and recurring costs that add little value
Match stock orders to actual demand so less cash sits on your shelves
Space out large purchases or lease equipment to spread the cost
Raise prices or add a complementary service to lift operating cash flow

Small gains across several areas can add up to more than one big change. Review your FCF each month to see which steps make the biggest difference.

Benefits and limitations of free cash flow

Free cash flow is a practical metric, and it works best when you know what it can and can’t tell you. Here’s what it does well.

Reflects real cash movements, so it’s harder to distort than net profit
Helps you budget for investments and debt repayments with more certainty
Lets you benchmark performance across periods or against similar businesses
Gives lenders and potential buyers a clear view of your cash generation

It also has limits, and a few common mistakes can skew what the figure tells you. Keep these in mind when you read your results.

Swings sharply after a large one-off purchase, even when trading is healthy
Leaves out loan repayments and owner drawings, so it shows only part of your cash commitments
Rises temporarily if you delay purchases or push collections harder
Misleads if you estimate it from profit without adjusting for working capital changes

Pair FCF with your profit margins and cash flow statement for a fuller view.

Manage your cash flow with confidence using Xero

Knowing your free cash flow helps you plan investments and handle quiet months calmly. The better your records, the easier that planning becomes.

Xero brings your bank transactions and reports together, and cash flow forecasting shows where your balance is heading. Whether you’re planning your next equipment purchase or preparing a loan application, you’ll have up-to-date numbers ready. Try Xero today and get one month free.

FAQs on free cash flow

Here are quick answers to common questions about free cash flow.

Is free cash flow the same as EBITDA?

They’re different measures: EBITDA is a profit figure from your income statement, while FCF comes from cash flow figures. A business buying lots of equipment can show healthy EBITDA alongside weak free cash flow.

Can a profitable business have negative free cash flow?

Yes. Profit is recorded when you invoice, so a growing business waiting on customer payments can be profitable while its cash runs low.

What is a good free cash flow?

There’s no single target figure, because healthy levels vary by industry and growth stage. A useful test is whether your FCF stays positive and covers your planned loan repayments and investments.

How often should you calculate free cash flow?

Monthly suits businesses with tight cash or seasonal peaks such as Lebaran, while quarterly works if your income is steady. Also calculate it before big decisions, such as applying for a loan or buying equipment.

Where do you find capital expenditure?

If you don’t prepare a cash flow statement, add up asset purchases from your supplier invoices for the period. You can also compare fixed assets across two balance sheets and add back depreciation for the period.

Learn more about free cash flow

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Disclaimer

This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.

What is free cash flow?

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