What is free cash flow (FCF)?

Profitability looks good on paper, but cash keeps the business running. Most companies falter because they run out of liquidity, regardless of their profit margins.

That makes free cash flow your financial reality check. It reveals the actual cash remaining after you cover operating expenses and capital expenditures.

In this post, you'll learn what free cash flow means, how to calculate it, which components influence it, industry benchmarks, common mistakes, and how to track it in Runway. Whether you're building finance models or managing cash, keep this guide handy.

Understanding free cash flow (FCF): the basics

Free cash flow is the cash your company has after covering operating expenses and capital expenditures. It's the money you use to pay down debt, reward shareholders, or fuel growth.

The formula is simple:

Free cash flow = operating cash flow – capital expenditures

Operating cash flow comes from your business operations. Free cash flow shows what stays after you've bought the fixed assets you need to run and grow.

It's not the same as net income. Net income includes adjustments like depreciation and amortization that don't impact your bank account. It's also different from EBITDA, which skips capital spending. Free cash flow takes one more step and includes your investments in the business.

Plenty of teams show positive operating cash flow and negative free cash flow when they're buying new equipment or building out infrastructure. That's part of growth. The gap between them tells you how much reinvestment your business needs.

Why FCF matters for business strategy

Free cash flow is your company’s real constraint. It decides when you can hire, how fast you grow, and how prepared you are for a surprise.

Cash powers your runway. If you’re burning cash, your runway is the number of months until the cash runs out. When free cash flow turns positive, you extend your runway indefinitely. Each improvement in free cash flow adds weeks or months to your plan.

Free cash flow drives valuation. Investors use discounted cash flow (DCF) models to value your business based on its future cash generation. Companies with strong, growing free cash flow get higher valuations because they can fund themselves.

Free cash flow shapes your choices. When it's positive, you can pay dividends, buy back shares, pay down debt, or fund acquisitions; no new fundraising needed. Negative free cash flow means you still rely on outside funding to keep going.

For fast-growing tech teams, free cash flow margin reveals if growth is truly funded or just smoke and mirrors. In 2024, average SaaS companies grew revenue 30% but showed only 10-20% free cash flow margins. That gap is where you need to pay attention.

Calculating free cash flow: formula and key variants

Start with the standard free cash flow formula:

Free cash flow = operating cash flow - CapEx

You can calculate operating cash flow two ways. The indirect method starts with net income and adjusts for non-cash items and changes in working capital:

Operating cash flow = net income + non-cash expenses + changes in working capital

• Non-cash expenses include depreciation, amortization, stock-based compensation, and deferred taxes.
• Working capital changes track shifts in accounts receivable, inventory, accounts payable, and deferred revenue.

The direct method sums cash from customers and subtracts cash paid for operations:

Operating cash flow = cash received from customers - cash paid for operating expenses

Most teams use the indirect method because it's easier with typical financial statements.

Unlevered free cash flow (UFCF)

Unlevered free cash flow shows the cash available to all investors, both debt and equity holders, before debt payments. It's the cash your business generates regardless of capital structure. You'll usually see this used to calculate enterprise value.

Unlevered FCF = EBIT × (1 - tax rate) + depreciation & amortization - CapEx - change in working capital

This starts with EBIT, applies the tax rate, adjusts for non-cash items, and subtracts investments. Imagine your business with zero debt. That’s unlevered cash flow.

Levered free cash flow (LFCF)

Levered free cash flow is what’s left after paying debt obligations. It’s the cash for equity holders and shows up in equity value analysis.

Levered FCF = net income + depreciation & amortization – CapEx – change in working capital – debt repayments + new debt issued

This version includes interest payments and any debt principal movements, reflecting your actual capital structure.

Free cash flow to equity (FCFE)

Free cash flow to equity isolates the cash available to shareholders after all expenses, reinvestment, and debt. This is what’s actually available for dividends or buybacks. Investors use FCFE to judge if dividend or buyback plans are really sustainable.

FCFE = net income – (CapEx – depreciation) – change in working capital + (new debt issued – debt repayments)

Key components and what to watch

To get free cash flow right, pay close attention to a few specific areas.

Starting with operating cash flow vs. net income

Net income follows accrual accounting. Revenue gets recognized when earned rather than when paid. Expenses match a period rather than when you pay them. Operating cash flow ignores all that. When customers pay, cash comes in. When you pay a vendor, cash goes out.

You might show a profit but lack cash if customers pay slowly or inventory builds.

Picking the right capital expenditures

Capital expenditures are purchases of property, equipment, and long-lived assets. Not every CapEx is created equal.

• Maintenance CapEx keeps current operations running. Think about replacing old equipment or upgrading systems to stay current.
• Growth CapEx expands capacity or enters new markets. Investments like building a new facility or launching new products fuel growth.

The distinction matters. Maintenance CapEx is necessary while growth CapEx is optional. Some analysts subtract only maintenance CapEx to calculate owner earnings. This shows the cash your business can pay out without hurting future performance.

Working capital changes

Working capital is current assets minus current liabilities. Changes here impact cash flow directly.

• When accounts receivable go up, you invoiced but haven't received cash so cash flow drops.
• When inventory rises, you bought goods not yet sold which also reduces cash flow.
• When accounts payable rise, you delayed payments to suppliers which boosts cash flow.

Working capital swings can be bigger than profit. A jump in receivables can wipe out your reported profit in cash flow terms. Retailers pre-stock inventory for holidays, so operating cash flow dips in Q3 and Q4. It rebounds in Q1 when inventory sells and receivables come in.

How to handle stock-based compensation

Stock-based compensation is non-cash on the income statement, so you add it back when calculating operating cash flow. It isn't cost-free since issuing stock dilutes current shareholders over time.

Many analysts adjust free cash flow to reflect the real cost of stock-based comp. This adjustment helps especially in high-growth tech companies where stock makes up a big chunk of compensation.

One-time or non-recurring cash flows

Some cash inflows and outflows happen once. Legal settlements, tax refunds, large prepayments, or big restructuring costs can distort a single period's free cash flow. Keep one-time items separate for accurate forecasting and trend spotting. Use both GAAP free cash flow and an adjusted version that strips out unusual charges.

Capitalized software development costs

Some software development costs get capitalized and depreciated over time rather than expensed right away. This lowers reported CapEx and bumps up free cash flow.

The cash is still spent. Check how each company treats software development when you compare free cash flow. Some expense up front while others capitalize. The difference matters in SaaS or software-driven companies.

Special challenges for fast-growing teams

Fast-growing teams often show negative free cash flow because they reinvest heavily in growth. They hire, build infrastructure, and spend on sales and marketing to win market share.

Negative free cash flow works fine when it funds real growth and returns. You just need to answer the big question about when free cash flow turns positive so the business can stand on its own.

Benchmarks and industry standards

Free cash flow benchmarks vary by industry, growth stage, and business model. You need to assess your performance against peers facing similar challenges.

Expectations by growth stage

Mature companies usually aim for positive and rising free cash flow. Since they have a solid foundation, they generate cash from ongoing operations. Top SaaS companies target over 20% free cash flow margin combined with more than 75% gross margin.

High-growth businesses prioritize expansion, so they often operate with negative free cash flow. That works as long as there is a clear plan to turn positive later. Investors focus on the timing and the path to sustainability rather than immediate cash generation.

• Early teams rarely post positive free cash flow. You demonstrate value by controlling your model and forecasting accurately.
• Later-stage owners need to show a concrete route to sustainable free cash flow.

Industry nuances

Free cash flow looks different depending on where you operate. Software companies generally score high margins because of low capital needs. In fact, SaaS firms frequently show positive free cash flow before they show GAAP profits. Customers prepay subscriptions, which brings cash in upfront even though you recognize revenue over time.

Manufacturing and retail businesses typically post lower margins due to heavy capital requirements. Energy companies face volatility tied to commodity cycles and large infrastructure investments.

The free cash flow conversion rate

You can measure earnings quality using the free cash flow conversion rate. You calculate this by dividing free cash flow by net income.

• Rate over 100%: You bring in more cash than your profits show. This usually happens because of efficient working capital management or light capital needs.
• Rate under 100%: Large purchases or working capital needs are consuming your cash.

Common mistakes and how to avoid them

Know your definitions

Don't mix up free cash flow, net income, and EBITDA. Net income bakes in accounting adjustments that don’t match cash, while EBITDA skips capital spending. Profit is the leftovers after expenses. Cash flow is actual money in and out. You might show a profit but run low on cash if collections are slow or inventory grows.

Be sure to use the correct metric for your goal. Use unlevered cash flow for enterprise value and levered for equity value. Be careful not to skip mandatory debt repayments. Free cash flow before debt service isn’t available to owners.

Watch the timing

Accrual accounting records revenue when earned, not when paid. You can book strong revenue but short cash if payment terms are long.

• Monitor working capital. These shifts can be larger than profits. A retail team could show high profits in Q4 but run low on cash after building inventory in Q3.
• Track deferred revenue. In SaaS, changes here change operating cash flow. If deferred revenue drops, you’re recognizing revenue from past cash.

Separate your spending

Don’t blend maintenance CapEx and growth CapEx together. Only maintenance CapEx is essential. Growth CapEx should stand alone so you can judge its value.

Watch out for capitalized expenses. Capitalizing software lowers reported CapEx and increases free cash flow, but the cash still leaves the account. Also, keep acquisition costs separate. These one-time outflows can overshadow your ongoing business performance.

Context is key

Fast-growing teams look different than mature players. Negative free cash flow can be a positive growth sign when managed right.

Don't forget that stock-based compensation has a cost. It doesn’t hit your bank account, but it dilutes ownership. Adjust free cash flow to reflect the real economic impact. Finally, separate one-time cash flows like big settlements or refunds. Isolate these from core free cash flow to see your long-term trends clearly.

Calculating free cash flow in Runway

To get a clear view of Free Cash Flow (FCF), you'll combine your general ledger data with Runway's driver-based modeling. This approach lets you track historical accuracy while projecting future cash positions in the same view.

1. Centralize your GL data. Start by connecting your accounting system (like QuickBooks, Xero, or NetSuite) so your GL data lands directly in a Runway database. Create a root database patterned after an Income Statement using your integration query as the source and Amount as the driver. Make sure to include segments for Vendor, Class, and GL Account Name so you have the granular detail you need.
2. Categorize your accounts. Build a small mapping database sourced from your root GL database and segmented by GL Account Name. Add a Dimension column called Cash Flow Category and tag each account with values like Operating CF or Capex. You'll then use this mapping as a lookup on your root database to auto-fill the category for every transaction.
3. Aggregate cash flow categories. Create a new "Cash Flow by Category" database that uses your root GL database as its source. Remove granular segments like Vendor so the data rolls up entirely by Cash Flow Category. This gives you one clean row per category, mirroring the rollup structure used in P&L modeling.
4. Isolate operating cash flow and capex. Open a Page and add a Driver table block. When you add the driver from your category database, drill into the specific segments to create distinct rows for Operating Cash Flow and Capex. If your GL records Capex as a negative number but you prefer modeling it as a positive use of cash, flip the sign using the formula editor. These drivers naturally respect the Last close boundary, handling actuals and forecasts automatically.
5. Define the Free Cash Flow driver. Add a new Number driver called Free Cash Flow to your table. Set the forecast formula to calculate the difference between your operating cash flow and capital expenditures (e.g., Operating Cash Flow - Capex). You can let the actuals inherit this same logic. This creates a single driver that transitions seamlessly from historical FCF to your projected runway.
6. Analyze and report. Keep your component drivers and FCF metric together in the table to visualize the full bridge. You can adjust the time granularity to see quarterly or trailing 12-month results without changing your underlying formulas. To see how different plans impact your cash position, compare your FCF across scenarios using Runway's Budget vs. Actuals tools.

Frequently asked questions

Is negative free cash flow always bad news?
Not necessarily. Negative cash flow often signals you're investing heavily in growth. Young, scrappy companies often spend cash to build infrastructure or acquire customers. The key is having a clear path to positive territory. It becomes a problem only when you burn cash without generating long-term value or when your runway gets too short to pivot.

How often should I check my free cash flow?
Check it monthly at a minimum. If your cash position is tight or you are managing a turnaround, track it weekly. Regular monitoring helps you catch trends early. It stops you from firefighting later. You want to spot a dip in collections or a spike in spending while you still have time to adjust.

Why is my profit positive but my free cash flow negative?
Profit is an accounting concept. It doesn't equal cash in the bank. You might have recognized revenue that customers haven't paid yet. You might have bought expensive inventory that is sitting on shelves. Or perhaps you made a large equipment purchase. Free cash flow tracks the actual movement of money, which explains why a profitable business can still run out of cash.

What is the best way to forecast free cash flow?
You need a tool that handles driver-based modeling and connects to your live data. Static spreadsheets break easily when you add complex variables. Runway helps here by connecting directly to your general ledger and letting you build flexible scenarios. It gives finance teams and model owners the control to test "what-if" plans without getting stuck in formula errors.

Does cutting costs always improve free cash flow?
Cutting costs is the fastest lever to pull, but it isn't always the best one. Indiscriminate cuts can hurt your ability to generate revenue. Better strategies often involve optimizing working capital. Negotiate better payment terms with suppliers or chase down overdue invoices from customers. These moves improve liquidity without damaging your growth engine.

Put free cash flow to work

Free cash flow cuts through accounting noise and shows your true ability to generate cash. When you understand what's real, you stop guessing and start planning with confidence.

Track free cash flow, revenue, and burn rate together in one place. These numbers drive every major decision on hiring, growth, and capital investment. You can build scenarios to see how a small shift in sales or working capital changes your future cash position instantly.

Runway keeps your finance team moving fast. Connect your data sources, build your driver-based model, and monitor free cash flow in real time. Share dashboards and test scenarios to collaborate across the business without vendor delays or missed context.

Ready to see the difference? Book a demo and see how teams forecast better, plan together, and make smart moves.