Free cash flow
Free cash flow is the cash left after covering operating costs and capital expenditure. Here's how it works.
Published Thursday 23 July 2026
Table of contents
Free cash flow formula.
Key takeaways
- Free cash flow is the cash left over after you cover your operating costs and capital expenditure. It shows whether your business can keep running and still grow.
- The formula is simple: operating cash flow minus capital expenditure. Both figures come straight from your accounts.
- Lenders and investors look at free cash flow to judge how healthy and self-funding your business really is.
- Negative free cash flow isn't always a problem, but if it lasts for a long time it's a warning sign worth acting on.
What is free cash flow?
Free cash flow is the cash left over after your business covers its operating costs and its capital expenditure, which is the money you spend on assets. It shows whether you can maintain or grow your business while still turning a profit.
It's a figure lenders and investors use most often. A strong, steady free cash flow tells them your business can fund itself rather than lean on outside money to stay afloat.
Free cash flow formula and how to calculate it
You can work out free cash flow with one short calculation. You take the cash your business generates from trading, then subtract what you spend on assets.
The formula is:
free cash flow = operating cash flow − capital expenditure
Operating cash flow is the cash your day-to-day trading brings in, after paying running costs like wages, rent and supplies. You'll find it on your cash flow statement. Capital expenditure is the money you spend on longer-term assets such as equipment, vehicles or property. To learn more about that side of the calculation, see our guide to capital expenditure.
Free cash flow example
A quick example shows how the numbers come together. Say you run a small joinery workshop in Hamilton and you want to check your free cash flow for the year.
Your operating cash flow for the year is $120,000. During the same year you spend $30,000 on a new saw and a delivery van, which counts as capital expenditure.
Subtract the $30,000 from the $120,000 and you're left with free cash flow of $90,000. That's the cash you have free to pay down debt, reward owners or reinvest in the business.
Why free cash flow matters
Free cash flow tells you whether your growth plans are affordable. A business that can't keep making a profit while paying for the improvements it needs looks risky to investors and lenders.
As an owner, you can use the figure to make practical calls. It helps you judge whether you can fund an expansion from your own cash, and it helps you prioritise which upgrades to make first.
Tracking it over time also gives you an early read on momentum. If your free cash flow keeps climbing, you have more room to invest with confidence and less need to borrow.
Free cash flow vs cash flow, working capital and liquidity
Free cash flow sits alongside a few related terms that are easy to mix up. Here's how each one differs:
- Cash flow: the general movement and availability of cash in and out of your business
- Liquidity: how easily your business can cover its upcoming costs, usually shown as a ratio
- Working capital: how much is left once you've covered those upcoming costs
- Free cash flow: the cash left after you've also made your capital investments
Can free cash flow be negative?
Yes, free cash flow can be negative. It simply means more cash went out than came in over the period you're measuring.
That isn't always bad. If you're investing heavily to grow, for example buying new premises or equipment, a negative figure can be a sign of ambition rather than trouble.
The concern is when it lasts. Sustained negative free cash flow is a warning sign that your business is spending more than it earns, so it's worth reviewing your costs and forecasts early.
Stay on top of your cash flow with Xero
Free cash flow is easiest to manage when your numbers are always up to date and easy to read. With online accounting software you can see your cash position, run reports and plan ahead without wading through spreadsheets. To build confidence in the numbers behind your free cash flow, it also helps to keep an eye on the future with cash flow forecasting. Try Xero and get one month free.
FAQs on free cash flow
Here are answers to some frequently asked questions about free cash flow.
How do you calculate free cash flow?
Start with your operating cash flow, then subtract your capital expenditure for the same period. A quarterly check works well if you want to spot changes before they build up.
What's the difference between free cash flow and operating cash flow?
Operating cash flow only counts the cash from your day-to-day trading. Free cash flow goes a step further and takes out what you spend on assets, so it shows what's genuinely free to use.
Is a high free cash flow good?
A high figure usually points to a healthy, self-funding business. Just check it isn't high because you've delayed necessary investment, as that can hold back growth later.
Can free cash flow be negative?
Yes, and a one-off negative figure is often fine when you're investing to grow. Keep a close watch if it stays negative across several periods in a row.
Related terms
Learn more about free cash flow
Handy resources
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Cash flow statement template
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Financial reporting
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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.