How to Calculate Free Cash Flow Using EBIT
Free cash flow is an important metric that shows how much cash a company has generated after accounting for capital expenditures, working capital changes, and other investments. It is a crucial indicator of a company’s financial health and ability to fund growth opportunities. One way to calculate free cash flow is to use EBIT, or earnings before interest and taxes. In this guide, we will walk you through the steps to calculate free cash flow using EBIT.
Gather Financial Statements
Before you can calculate free cash flow using EBIT, you will need to gather the relevant financial statements. These include the income statement, balance sheet, and cash flow statement. Make sure you have access to the most recent financial statements for the company you are analyzing.
EBIT is a measure of a company’s profitability that shows earnings before interest and taxes. To calculate EBIT, you will need to subtract the cost of goods sold (COGS) and operating expenses from total revenue. The formula for EBIT is:
EBIT = revenue - COGS - operating expenses
Calculate Depreciation and Amortization
Depreciation and amortization are non-cash expenses that are added back to EBIT when calculating free cash flow. To calculate depreciation and amortization, you will need to refer to the company’s balance sheet and look for the line items labeled “accumulated depreciation” and “amortization expense.” Add these two figures together to get the total amount of depreciation and amortization for the period.
Calculate Capital Expenditures
Capital expenditures are investments in long-term assets such as property, plant, and equipment. To calculate capital expenditures, you will need to refer to the company’s cash flow statement and look for the line item labeled “capital expenditures” or “purchase of property, plant, and equipment.” This figure represents the total amount of capital expenditures for the period.
Calculate Changes in Working Capital
Working capital is the difference between current assets and current liabilities. Changes in working capital can have an impact on free cash flow. To calculate changes in working capital, you will need to refer to the company’s balance sheet and compare the current period’s working capital to the previous period’s working capital. If working capital has increased, it will be subtracted from free cash flow. If working capital has decreased, it will be added to free cash flow.
Calculate Free Cash Flow
Now that you have all of the necessary figures, you can calculate free cash flow using the following formula:
Free Cash Flow = EBIT + Depreciation and Amortization - Capital Expenditures - Changes in Working Capital
By using EBIT as a starting point, you can see how much cash a company is generating from its core operations. Adding back depreciation and amortization helps to account for non-cash expenses, while subtracting capital expenditures and changes in working capital gives you a better idea of the company’s true free cash flow.
In conclusion, calculating free cash flow using EBIT is an important step in analyzing a company’s financial health and growth potential. By following the steps outlined in this guide, you can calculate free cash flow with confidence and use this metric to make informed investment decisions.