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Free Cash Flow Yield (FCFY) Definition – Explanation – Calculation

What Is Free Cash Flow Yield (FCFY)?

Free Cash Flow YieldThe free cash flow yield (FCFY) is a financial solvency metric that compares a company’s predicted free cash flow per share to its market value per share. The ratio is computed by dividing free cash flow per share by the current share price. As an analytical tool, free cash flow (FCF) is valuable for determining a company’s operating potential. Businesses with robust cash flows are generally financially sound.  However, firms with weak FCFs may be unable to satisfy their short-term obligations.

By comparing free cash flows to market value, the Free Cash Flow Yield gives additional insight into a firm’s operating strength. A low FCFY implies that investors are injecting more money into the company than the profits it earns. Financial analysts examine FCF yield in conjunction with a firm’s capital expenditures.  This extra step helps to determine whether possibly poor FCFs can be justified by fixed asset investments.

Free Cash Flow Yield Formula

The computation of free cash flow yield is straightforward. The free cash flow yield is simply the free cash flow divided by the company’s market value.

Free Cash Flow Yield = Free Cash Flow per Share / Market Price per Share

Free cash flow yield is calculated by deducting capital expenditures from all cash flow activities.  The information can be found on a company’s cash flow statement. The free cash flow value is then divided by the company’s value or market capitalization. Financial analysts constantly monitor business performance and operations.  They report the market value of nearly all publicly traded corporations. If a company’s market cap isn’t readily available, it may be calculated by multiplying the share price by the number of outstanding shares.

What Does the Free Cash Flow Yield Reveal?

Free cash flow yield is an important indicator for financial and market experts, as well as investors. It serves as an indicator of a company’s ability to repay and fulfill all of its commitments. In essence, it is a simple, yet reliable predictor of a company’s financial stability.

In general, the lower the FCFY ratio, the less appealing a firm is as an investment.  It indicates that investors are investing money into the company but are not obtaining a particularly strong return. Conversely, a high free cash flow yield indicates the corporation generates cash.  Potentially enough to meet its debt and other commitments, including dividend distributions.

Cash flow from operations serves as a source of funding for a company’s long-term capital projects. This is in addition to supporting ongoing operations.  So, a company’s operational cash flow is used to cover capital expenditure obligations before it seeks outside finance. Anything left over is known as free cash flow, and it is made accessible to equity holders and investors. Larger corporations are more likely to have a greater cash flow yield. But this is not always the case. The lower the free cash flow yield, the more money investors pour into the firm with little to show for it.

Why it Matters

Concentrating on firms with consistent free cash flow may be a solid strategy when choosing investment opportunities. Free cash flow is the cash left over after a firm has paid its costs, interest, taxes, and long-term obligations. FCF can be used to repurchase shares, pay dividends, or engage in mergers & acquisitions. A high free cash flow yield suggests that a firm is creating more cash than it needs to run the business.  In turn, this can then be invested in growth prospects.

Free cash flow businesses are distinguished by three characteristics.  They are productive, dependable, and self-sufficient. The enterprises create more cash flow than they spend, allowing them to develop without the need for outside funding. Unlike earnings, free cash flow is a reliable metric of profitability not subject to manipulation or accounting assumptions. Finally, because the enterprises rely less on capital markets for financing, they do not dilute their issued company shares. (Source: nasdaq.com)

The Difference Between Cash Flow and Earnings

Free cash flow is a direct result of operating cash flow.  It is the net outcome of real cash received and paid to a company through its core operating activities. Therefore, using cash flow to gauge operating success differs from using an accounting-based earnings report. Earnings account for all aspects of income and cost, independent of the cash component. Therefore, earnings describe a company’s entire net income.  Conversely, cash flow is concerned with a company’s capacity to continue operations. The more cash a firm generates through operations, the easier it is to carry out its activities.  As a result, the easier it is to generate greater earnings. Arguably, the capacity to yield cash flow can provide a more accurate picture of a company’s long-term value.

Free Cash Flow Yield – Conclusion

This ratio represents the percentage of money left over for shareholders in relation to the stock price. The ratio is extremely important to an investor since it pertains to the amount of value you receive for your investment dollar. A company’s cash flow may be strong in comparison to its assets.  However, its stock price may be so high that the value for the investor is poor. It’s also conceivable that cash flow relative to corporate assets is low.  But, the stock price is so cheap that the value for the investor is great. By comparing free cash flow to market capitalization (shares outstanding x stock price), you can calculate a percentage return on the stock value that may be used to benefit shareholders. This might include dividends, stock buybacks, debt reduction, or new investments and acquisitions.

FCFY aids in determining a firm’s strength. A negative free cash flow yield may signal that the company is insufficiently liquid.  As a result, it may require external capital to pay its debt obligations or sustain operations. An ongoing squeeze in free cash flow may negatively influence future profit growth. Rising free cash flow, on the other hand, enables enterprises to self-finance.  It limits the need for costly external funding for development, hence increasing shareholder value. However, FCFY cannot be regarded as the sole indicator for making investment decisions. Firms with strong growth may have good profitability.  However, their cash flows may be completely devoured by capital expenditures. As a result, despite excellent growth potential, these companies may post lower FCFY.

Frequently Asked Questions

What Does Free Cash Flow Yield Mean to Investors?

Free cash flow yield is a key statistic of operating performance. The higher a company’s FCFY, the more competent and probable it is to meet all of its debts and obligations. This applies to both the past and likely the future. Available cash applies to factors like dividend disbursements, which are very important to present equity holders.

What is Unlevered Free Cash Flow Yield?

The unlevered FCF yield indicates the company’s overall operational performance.  It demonstrates the amount of remaining cash that might be used to benefit all capital sources – debt and equity. The capital might, for example, be used to pay down obligatory debt obligations.  Or, satisfy interest cost payments, pay a dividend to common or preferred stockholders, repurchase shares.  Alternatively, it could be used to reinvest in the firm.

What is Levered Free Cash Flow Yield?

The levered FCF yield is computed by dividing the free cash flow per share by the current share price. It is influenced by a number of different elements.  For example, the financing mix, debt-equity ratio, and amortization. As a result, the levered FCFY ratio is typically regarded as an internal measure rather than a comparative statistic against competitors. It is used more to evaluate the company’s own prior performance.  Or, for investors to judge their cash flow value per unit of stock.

Up Next: What Are Accrued Expenses?

Accrued ExpensesAccrued expenses are liabilities a company needs to account for, but for which no invoice has yet been received and no payment has been made.

An accrued expense, also known as an accrued liability, is an accounting concept.  It refers to an expense that is recognized on the books before it has been paid. The expense is recorded in the accounting period in which it is incurred. The matching principle is used to match these costs to revenue. It stipulates that revenues and their related costs must be recorded in the accounting period in which they occur. This is true regardless of whether cash was received by the seller or paid out by the buyer.

 

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