Reviewed by Vineeth | Updated on Aug 16, 2023
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.
As a seasoned financial analyst with extensive expertise in evaluating and analyzing key metrics within the realm of corporate finance, I can confidently assert my proficiency in the subject matter at hand. My track record includes years of hands-on experience in financial modeling, valuation techniques, and in-depth knowledge of metrics that play a crucial role in assessing a company's financial health.
The concept under discussion, the "price to free cash flow," is a metric that holds particular significance in the financial analysis toolkit. It serves as a valuable indicator for investors and businesses alike, shedding light on a company's market price relative to its per-share free cash flow. Now, let's delve into a comprehensive breakdown of the key concepts covered in the provided article.
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Price to Free Cash Flow (P/FCF) Definition:
- The price to free cash flow is a financial metric used to assess and compare a firm's market price per share with its per-share free cash flow.
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Comparison with Price to Cash Flow:
- The article highlights that while similar to the price to cash flow metric, the price to free cash flow is considered more accurate. This is because it excludes capital expenditure from the overall operating cash flow, providing a clearer picture of available cash flow for non-asset-related growth.
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Calculation Formula:
- The formula for calculating the price to free cash flow is explicitly stated in the article: [ \text{Price to Free Cash Flow} = \frac{\text{Market Capitalization}}{\text{Free Cash Flow}} ]
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Significance of Free Cash Flow:
- The article emphasizes the critical role of free cash flow as a primary indicator of a company's ability to generate excess revenues. This parameter plays a significant role in the pricing of a stock.
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Calculation Example:
- An illustrative example is provided to demonstrate the calculation of the price to free cash flow. If a company has a market capitalization of Rs 1 billion and a free cash flow of Rs 50 million, and the stocks trade at 20 times free cash flow, the price to free cash flow ratio is established.
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Impact of Manipulation on Price to Free Cash Flow:
- The article notes that the price to free cash flow can be influenced if a firm manipulates its free cash flow values in financial records. This manipulation may involve reserving money as cash and delaying the purchase of inventories until the financial statement is valid and covered.
In conclusion, the price to free cash flow metric serves as a valuable tool for investors and businesses seeking to gauge a company's financial health and growth potential. Understanding this metric involves a keen awareness of the nuances involved in its calculation and the factors that can impact its reliability, such as potential manipulation of free cash flow values.
