Price to Free Cash Flow

Reviewed by Vineeth | Updated on Aug 26, 2020

Introduction

The price to free cash flow is a metric used to evaluate and compare a firm’s market price of a single share with its per-share price of free cash flow (FCF). This metric is much like the evaluation metric of price to cash flow. However, it is deemed a more accurate measure as it accounts free cash flow which does not include the capital expenditure of a firm’s overall operating cash flow. Hence, it shows the exact available cash flow to fund a growth which is non-asset-related.

Firms and businesses make use of this metric at times when they are expanding their asset bases to grow their revenues or to keep up with an acceptable amount of free cash flow.

The price to free cash flow is calculated as shown below: Price to free cash flow = (market capitalisation)/(free cash flow)

Understanding Price to Free Cash Flow

The free cash flow of a company is critical as it is a primary indicator of the ability to provide excessive revenues which is a significant parameter when it comes to the pricing of a stock.

A company's price to cash is obtained by using the formula: price to free cash flow = (market capitalisation)/(total free cash flow)

For instance, a firm having Rs 100 million as its overall operating cash flow and Rs 50 million for its capital expenditures can have a free cash flow of Rs 50 million. If the firms’ market capitalisation is valued at Rs 1 billion, the stocks of the firm trade at 20 times free cash flow, which is Rs 1 billion per Rs 50 million.

The price to free cash flow can be impacted if the firm manipulates their values of free cash flow in their financial records through reserving money in the form of cash and putting off the purchase of inventories till the time the financial statement is valid and covered.