Free cash flow (FCF)
Learn what free cash flow is, how to calculate it and how to use it to plan your business spending.
Published Wednesday 30 September 2026
Table of contents
Free cash flow formula.
Key takeaways
- Free cash flow is the cash your business has left after paying its operating costs and capital expenditure
- It tracks real cash, so it can differ from profit, which includes non-cash items like depreciation
- Calculating it monthly or quarterly helps you spot cash shortfalls early and plan big purchases
- You can improve it by collecting payments sooner and timing your capital spending carefully
What is free cash flow?
Free cash flow (FCF) is the cash your business has left after paying its operating costs and capital expenditure. It’s the money you can use to repay debt or fund growth.
Picture your business as a household. Operating cash flow is your salary, and capital expenditure is a new car or roof repair. What’s left in the account afterwards is your free cash flow.
Your business can show a profit on paper while its cash sits in stock or unpaid invoices. Under accrual accounting, you record income when you earn it, which is why profit and cash drift apart. Free cash flow shows what your bank balance can actually support.
Why free cash flow matters
Free cash flow shows you and your lender whether your business makes enough cash to run and grow. Revenue and profit show what you’ve earned, and free cash flow shows what you can spend.
Tracking it regularly gives you these advantages.
- You see how much cash you can put toward growth or debt repayment
- You can spot a cash shortfall months ahead and adjust your plans early
- You give banks evidence that your business can take on and repay new financing
- You can judge whether it’s the right time to hire or hold off on a big purchase
Cash pressure is common among Malaysian small and medium enterprises (SMEs). In a 2026 SME Association of Malaysia survey reported by the New Straits Times, only 9.8% of SMEs described their cash flow as healthy. In the same survey, 49% said they were already under pressure and may need financing support.
When cash is tight, your free cash flow figure tells you where to cut costs and when to delay upgrades. It also shows whether it’s time to look for extra funding.
Free cash flow formula
The standard formula subtracts capital expenditure from the cash your day-to-day trading brings in.
Free cash flow = operating cash flow – capital expenditure
Here’s what each part of the formula means.
- Operating cash flow (OCF): this is the cash from your regular trading, such as customer payments minus supplier and staff costs. You’ll find it on your cash flow statement, often labelled “cash from operations”.
- Capital expenditure (capex): this is money you spend on long-term assets, such as equipment, vehicles, technology or a shop renovation.
If your operating cash flow includes interest paid, the result is levered free cash flow, meaning it’s measured after interest. Unlevered free cash flow is measured before interest, so it shows the cash your operations make whatever your mix of loans and owner funding. The Corporate Finance Institute’s free cash flow formula guide sets out both versions.
How to calculate free cash flow
You can work out free cash flow in four steps once your financial statements are ready. Each step uses figures from your cash flow statement.
1. Find your operating cash flow
Start with your cash flow statement and find the line for cash flows from operating activities. This figure is your net profit adjusted for non-cash items like depreciation and for changes in working capital.
Malaysian companies prepare this statement under Malaysian Financial Reporting Standards (MFRS), which are identical to International Financial Reporting Standards (IFRS). Private entities can use the Malaysian Private Entities Reporting Standard (MPERS) instead, as the IFRS Foundation’s Malaysia profile confirms.
2. Identify your capital expenditure
Next, find your capital expenditure in the cash flows from investing activities section. It covers purchases of property, equipment, vehicles and other long-term assets.
Accounting software can pull these figures straight from your financial reports, which saves you rekeying numbers by hand.
3. Subtract capital expenditure from operating cash flow
Take your operating cash flow and subtract your capital expenditure. The result is your free cash flow for the period you’re analysing.
4. Compare your results across periods
One figure is a snapshot, so track free cash flow monthly or quarterly. Comparing periods shows you trends and seasonal patterns before they turn into cash pressure.
Free cash flow calculation example
To see the formula in action, imagine you run a landscaping business in Penang, and your quarterly cash flow statement shows these figures.
- RM85,000 in operating cash flow
- RM20,000 in capital expenditure for a new mower and trailer
Using the formula, free cash flow = RM85,000 – RM20,000 = RM65,000.
You have RM65,000 left that quarter after covering running costs and new equipment. You could use it to pay down a loan or build an emergency fund.
Next quarter, operating cash flow drops to RM60,000 and you spend RM35,000 on a used lorry. Your free cash flow falls to RM25,000. That’s expected after a planned purchase, and it’s a cue to go easy on discretionary spending for a while.
How free cash flow compares to other financial metrics
Free cash flow is one of several metrics that show how healthy your business is. Each measures something different, so it helps to see how they relate.
- Free cash flow vs cash flow: cash flow covers all cash moving in and out of your business, including investing and financing. Free cash flow narrows this to cash left from operations after capital expenditure.
- Free cash flow vs operating cash flow: operating cash flow is the cash from day-to-day trading before spending on long-term assets. Free cash flow goes one step further by subtracting capital expenditure.
- Free cash flow vs EBITDA: earnings before interest, taxes, depreciation and amortisation (EBITDA) measures profit before interest and tax. It ignores what you spend on assets. Free cash flow subtracts capital expenditure and reflects the tax you actually pay, so it’s closer to spendable cash.
- Free cash flow vs working capital: working capital compares current assets with current liabilities at one point in time, as shown on your balance sheet. Free cash flow measures the cash your business generates over a period.
- Free cash flow vs net profit: net profit includes non-cash items like depreciation and depends on accounting choices. Free cash flow adjusts for those items to show the cash your business produced.
- Free cash flow vs liquidity: liquidity describes how easily you can get cash or turn assets into cash. Free cash flow is one measure that feeds into your overall liquidity.
Tracking free cash flow alongside these measures gives you a fuller view of where your business stands.
Types of free cash flow
There are two main types of free cash flow, and each one depends on who the cash is available to. The difference comes down to how interest and debt are treated.
- Free cash flow to the firm (FCFF): this is the cash available to everyone who funds your business, lenders and owners alike. It’s measured before interest, because interest is a payment to lenders, who share in this cash.
- Free cash flow to equity (FCFE): this is the cash left for owners only, after interest and debt flows like loan repayments and new borrowing. It’s the amount you could pay out as dividends or keep as retained earnings.
The Corporate Finance Institute’s comparison of FCFF and FCFE walks through how each is calculated. For everyday decisions, the standard formula works well, and FCFF and FCFE become more useful when you’re seeking investment or preparing to sell.
If you’re valuing or selling your business, a buyer may also look at the price-to-free cash flow ratio. It compares the price of a business with the free cash flow it generates. The result shows what a buyer pays for each ringgit of free cash flow.
How to interpret free cash flow
Your free cash flow figure means more once you read it in context. Look at whether it’s positive or negative, then at how it moves over time.
Positive free cash flow means your business makes 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 point to a stable business.
Negative free cash flow can be a normal result of a large, planned investment, such as new equipment or a second location. Watch whether it’s a one-off or a recurring pattern. Ongoing negative results with no clear cause mean you’re spending more cash than you bring in.
Trends tell you more than a single number, so review at least three or four quarters. A steady rise shows stronger cash generation. A falling trend is your cue to check costs and collections, even while the figure is still positive.
Wider market conditions also shape your results. A dip in a slow trading period can come from higher costs or weaker demand across your industry. Read your numbers alongside what’s happening in your market.
How to improve free cash flow
You can lift free cash flow by bringing cash in sooner and paying it out later. These steps can help.
- Send invoices promptly and use online invoicing so customers can pay you more easily
- Check your accounts receivable each week and follow up overdue payments
- Ask suppliers for longer payment terms so cash stays in your account for longer
- Review subscriptions and services, and cut the ones you rarely use
- Match stock orders to what’s actually selling, since excess inventory ties up cash
- Space out large purchases or lease equipment to spread the cash cost
- Raise prices or add a complementary service to boost operating cash flow
Small gains across several areas often add up to more than one big change. Review your free cash flow each month to see which steps are working best.
Benefits and limitations of free cash flow
Free cash flow is a practical measure, and knowing its limits helps you use it well. Its main benefits come from being based on cash.
- It’s based on actual cash movements, so it’s harder to distort than net profit
- It helps you budget for investment and unexpected costs with more confidence
- It lets you benchmark results across periods or against similar businesses
- It gives lenders and buyers a reliable sign of your ability to generate cash
Keep these limitations in mind too.
- It can swing sharply, since one large equipment purchase can turn a quarter negative
- It’s measured before loan repayments and owner drawings, so plan for those commitments separately
- It moves with timing, as delaying a purchase or collecting early can lift one period’s figure
- It works best alongside your profit margins and cash flow statement
Manage your cash flow with confidence using Xero
Knowing your free cash flow helps you plan your next investment and prepare for quieter months. The earlier you spot a cash gap, the more options you have to close it.
Xero gives you a real-time view of your cash, with cash flow forecasting tools and automated bank feeds that keep your figures up to date. Try Xero and get one month free to see how simple tracking your cash can be.
FAQs on free cash flow
Here are answers to common questions about free cash flow.
What is a good free cash flow?
It depends on your industry and growth stage. A healthy sign is free cash flow that stays positive and comfortably covers your loan repayments and owner drawings.
Can free cash flow be higher than net profit?
Yes. It can happen when large non-cash expenses like depreciation reduce profit while your capital spending stays low.
What is free cash flow margin?
Free cash flow margin is free cash flow divided by revenue, shown as a percentage. It tells you how much of your sales turns into cash you can use.
Does free cash flow include loan proceeds?
Money from a new loan is financing cash flow, so it stays out of the standard formula. Adding it would overstate how much cash your operations generate.
Related terms
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.