Free Cash Flow: Formula and Examples

Free cash flow (FCF) is the cash a business has left after paying its operating costs and investing in the equipment, vehicles and property it needs. The basic formula is operating cash flow minus capital expenditures. It is the money genuinely available to repay loans, pay owners, build a cash reserve or fund growth, which is why lenders, buyers and investors watch it more closely than profit.

This guide explains the main free cash flow formulas, works through an example for a small service business, shows the difference between levered and unlevered FCF, and covers how small business owners can use FCF to decide how much to draw, borrow or invest.

Free cash flow formulas

Version	Formula	Used for
Basic FCF	Operating cash flow - Capital expenditures	Everyday management, lending
Unlevered FCF (to the firm)	EBIT x (1 - tax rate) + Depreciation and amortization - Capital expenditures - Increase in net working capital	Business valuation, comparing companies with different debt
Levered FCF (to equity)	Basic FCF - Debt principal repayments + New borrowing	Owner distributions, dividends
FCF margin	FCF / Revenue	Efficiency over time

Because interest is an operating cash flow under US GAAP, basic FCF is already after interest. Free cash flow has no single official definition, so always state how you calculated it. Public companies that report it must explain the calculation and reconcile it to a GAAP measure under SEC non-GAAP rules, as described in this summary of Regulation G and Item 10(e).

Worked example: basic free cash flow

The figures are illustrative. A commercial cleaning company with $900,000 of revenue has operating cash flow of $81,000 for the year (see our operating cash flow guide for how that number was built). During the year it bought a van and floor equipment for $35,000.

Line	Amount
Operating cash flow	$81,000
Capital expenditures (van, floor machines)	($35,000)
Free cash flow	$46,000
Loan principal repaid	($12,000)
Levered free cash flow available to owner	$34,000
FCF margin ($46,000 / $900,000)	5.1%

Net income was $84,000, but the owner can only safely draw about $34,000 without reducing the bank balance or borrowing. If the owner draws $60,000, as the profit figure might suggest, cash falls by $26,000 in the year. This gap between profit and free cash flow is behind many small business cash crunches.

Worked example: unlevered free cash flow

For a valuation, a buyer would calculate unlevered FCF, ignoring how the business is financed. Assume operating profit (EBIT) of $109,000 and an assumed 25% tax rate for illustration:

Line	Amount
EBIT	$109,000
Less taxes at 25%	($27,250)
Plus depreciation	$18,000
Less capital expenditures	($35,000)
Less increase in net working capital	($21,000)
Unlevered free cash flow	$43,750

The $21,000 working capital increase is the net of higher receivables ($22,000) and supplies ($9,000), offset by a drop in prepaid expenses ($1,000), higher payables ($6,000) and higher accrued wages ($3,000). Buyers project this figure forward several years and discount it to value the business, which is why sustainable free cash flow, not one good year, drives the price. Valuations of small businesses also often use multiples of seller's discretionary earnings or EBITDA, but buyers still check them against cash.

Free cash flow vs operating cash flow vs net income

Measure	Starts from	Deducts capital spending?	Deducts debt principal?	Example
Net income	Revenue minus all expenses (accrual)	Only through depreciation	No	$84,000
Operating cash flow	Net income adjusted to cash	No	No	$81,000
Free cash flow	Operating cash flow	Yes	No	$46,000
Levered FCF to owner	Free cash flow	Yes	Yes	$34,000

Each step down the table gets closer to the money you can actually spend. Owners who plan their personal finances around the top line of this table are the ones most often surprised by an empty account in a good year.

Capital expenditures: maintenance vs growth

Not all capital spending is equal. Maintenance capex replaces worn-out equipment to keep the business running at its current size. Growth capex adds capacity: a second van, a new location, a larger oven. Separating the two gives a more honest picture:

• FCF after maintenance capex shows what the business throws off in a steady state.
• Growth capex is a choice; you can pause it in a tight year.

Our guide to CapEx vs OpEx explains which purchases count as capital expenditures, and how to calculate depreciation shows how they flow into the income statement over time.

Free cash flow and taxes in 2026

Tax rules affect FCF through the timing of deductions. The One Big Beautiful Bill Act of July 2025 restored 100% bonus depreciation for qualifying property acquired after January 19, 2025, so many businesses can deduct the full cost of equipment in the year they buy it. The deduction does not change the cash you spent, but it lowers taxes paid in that year, which raises operating cash flow and free cash flow. Later years have less depreciation left to deduct. Our comparison of Section 179 vs bonus depreciation covers the choices; this is general information, not tax advice, so confirm the treatment with your tax preparer.

How to use free cash flow in a small business: step by step

1. Calculate FCF quarterly from the cash flow statement or a simple bank-based summary.
2. Split capex into maintenance and growth.
3. Subtract debt principal to get the cash available to owners.
4. Set owner draws or distributions at or below that level, keeping a buffer for quarterly taxes.
5. Allocate the remainder between a cash reserve (often three months of operating costs), debt reduction and growth projects.
6. Track the FCF margin over several years to see whether the business is getting better at converting sales into cash.
7. Forecast it. Add FCF to your rolling forecast so big equipment purchases are planned rather than surprising.

Free cash flow in service vs product businesses

Service businesses such as consultants, agencies and bookkeepers usually need little equipment, so most operating cash flow becomes free cash flow. Their main FCF risk is receivables: a few large clients paying late can wipe out a quarter's free cash flow. Product and equipment-heavy businesses, such as manufacturers, trucking firms, restaurants and contractors, need regular capital spending just to stand still, so their FCF margin is structurally lower and lumpier. For them, a replacement schedule for vehicles and equipment is as important as the sales forecast.

Whatever the model, compare FCF over at least three years. A contractor who bought two trucks last year will show weak FCF that year and strong FCF the next, and neither year alone tells the true story.

What to do if free cash flow is consistently negative

1. Check operating cash flow first. If OCF itself is negative, the problem is pricing, costs or collections, not investment.
2. Separate growth capex. If maintenance-only FCF is positive, the business is healthy but expanding faster than it can self-fund.
3. Match financing to assets. Long-lived equipment should usually be financed with term loans or leases, not paid from operating cash.
4. Cut owner draws temporarily to the level FCF supports.
5. Attack working capital: collections, deposits, inventory levels and supplier terms.

How invoicing and collections drive free cash flow

Most of the levers that move FCF sit in working capital, and the largest working capital item for service businesses is receivables. In the example, $22,000 of extra receivables cut free cash flow by almost a third. Faster billing, shorter terms, deposits and easy payment options all convert to free cash flow dollar for dollar. Our guide to working capital explains the mechanics, and days sales outstanding shows how to measure collection speed.

Sending invoices the day work is complete, with clear due dates and payment links, is the cheapest FCF improvement available. The free invoice generator makes it quick.

Planning a large purchase around free cash flow

Before buying a significant asset, project FCF for the next 12 months with and without the purchase. Paying $60,000 cash for equipment when annual FCF is $46,000 means more than a year of free cash goes into one asset, leaving nothing for a slow season. Financing it over five years spreads the outflow, reduces the strain on reserves and lets the equipment pay for itself from the revenue it generates. The right answer depends on the interest rate, your cash reserve and how certain the extra revenue is, but FCF makes the trade-off visible. Add the decision to your forecast before you sign.

Common free cash flow mistakes

• Using EBITDA as free cash flow. EBITDA ignores capex, working capital, interest and taxes.
• Leaving out financed equipment. If a lender paid the dealer directly, there may be no cash outflow, but the business still acquired an asset and took on debt; note it.
• Ignoring lumpy capex. One year without equipment purchases makes FCF look unusually strong; average over several years.
• Drawing on profit, not FCF, as in the example above.
• Treating one negative year as failure when it reflects deliberate investment.

Free cash flow is the clearest answer to the question every owner asks: how much money did the business really make that I can use? Strengthen it at the source by billing promptly and clearly with the free invoice generator: no sign-up, and every invoice downloads as a PDF.