What's Free Cash Flow and Why It Matters

Inundated by numbers, investors often cling to the tried and true. For instance, they'll open an earnings report and zero right in on earnings per share (EPS) and revenue.

While that's understandable amid all the data, investors who rely on those metrics alone risk short-changing themselves. To better grasp a company's financial health, they should also consider tracking free cash flow.

"Investors often fixate on earnings, but they should consider evaluating free cash flow as well," said Michael Rawson, analyst at the Schwab Center for Financial Research (SCFR). "Free cash flow is where the rubber hits the road when it comes to company financial performance."

Though earnings can point to underlying financial trends, free cash flow gets to the heart of things. There are many ways to explain it, but basically, free cash flow is whatever cash is left in the till after a company pays its quarterly costs and collects its quarterly revenue. In a way, it's a cleaner cash-based measure of a company's financial health.

Earnings draw headlines but don't tell the entire story. For example, a company might make a large capital expenditure one quarter but spread the costs out over multiple reporting periods. This accounting move can make that quarter's earnings appear financially heartier than they really are. Free cash flow, however, provides a solid snapshot that tells investors if more cash is going out than coming in during a particular quarter.

EPS can also reflect share buybacks. Investors might be impressed if a company's EPS rises 10%, but that could reflect a 10% drop in the number of shares outstanding from a year earlier. In that scenario, earnings growth doesn't reflect appreciable impact from business operations—it's mostly, again, about accounting. Free cash flow isn't affected by share count, while EPS numbers are.

Free cash flow can also be measured over time to track corporate health. A company may have positive free cash flow one quarter, but what's the trend? Falling free cash flow over time could indicate weakness in the core business that ultimately leads to lower earnings and revenue, followed by more dramatic and negative measures like a dividend cut.

Investors who dig a little to track free cash flow might be more likely to detect downward trends in a company's finances before they show up in earnings and revenue numbers.

As S&P Global noted, "A company can be profitable but have little cash available." Companies with sufficient cash have better opportunities to grow their business or raise payouts to investors.

One way to think about this is that earnings are accrual based, while cash flow is cash based, an important distinction. Accrual means things like revenue earned or expenses incurred, not cash that's landed in the company's accounts and is on hand to use.

And while investors deciding where to place their money should keep in mind past performance does not indicate future results, S&P 500^® companies in the top quintile of free cash flow between 1990 and 2017 also had the best annualized returns. They averaged 15.7% annual returns in that period versus 12.2% for the entire S&P 500 Index and 8.6% for companies in the lowest quintile of free cash flow, according to S&P Global.

Healthy or improving free cash flow can allow a company to:

• Invest in its own business through acquisitions, attract key talent, build new facilities, and put money into research and development
• Raise dividends over time, meaning higher payouts for shareholders
• Buy back more shares, reducing share count and raising share value
• Pay off debt more quickly
• Prepare effectively for lean times when companies with poor free cash flow might have to cut back on investments or dividends
• Signal to investors that the company has strong financial management and a quality business, potentially leading to increased demand for its shares
• Borrow money at a lower interest rate, assuming ratings agencies see it as less of a credit risk
• Provide potentially higher returns for investors

S&P Global research found that companies in the top quintile of free cash flow yield outpaced the bottom quintile appreciably over a nearly two-decade period.

Companies can be compared by the price of their stock divided by their cash flow. On Schwab.com, select the Research tab, Stocks, and then Stock Compare. Up to five stock symbols can be compared at once. Scroll down to Valuation and then to Price/Cash Flow, which is the current price divided by cash flow per share for the most current fiscal year.

Cash flow from operations starts with net income, then adds depreciation and subtracts the increase in working capital.

Generally, a lower price per cash flow means investors get more cash flow for the price they pay for shares.

There's more than one way to calculate free cash flow, but a simple method is to check a company's statement of cash flows and subtract capital expenditures from cash flow from operations.

It's easy to confuse cash flow with free cash flow. Cash flow simply adds all the money used by a business to operate itself, make investments, and finance expenditures. That's different from net income, sometimes called the "bottom line," which refers to revenue minus expenses and doesn't consider when cash is actually received. Free cash flow is also different from net income because it accounts for the purchase of capital goods and changes in working capital, among other details.

The cash flow figure in a firm's financial statements reflects a company's financial activity over a period of time. It shows where a company's cash comes from and how it's used to pay for operations and/or to invest in the future.

By showing how a company has managed the inflow and outflow of cash, the statement of cash flows may paint a more complete picture of a company's liquidity—the ability to pay bills and creditors and fund future growth—than its income statement or balance sheet alone.

Free cash flow is what's left after all costs have been paid. Determining free cash flow means taking the additional step of subtracting capital expenditures.

Investors got a free lesson in free cash flow in the mid-2020s as the so-called "Magnificent Seven" firms invested heavily in AI, with annual expenditures in the hundreds of billions of dollars. This had a massive impact on companies' free cash flow and, in some cases, weighed on shares.

Until late 2025, capital spending by companies building data center capacity was financed from company cash flow and equity gains, not on the debt side.

That's shifting now and something to keep in mind.

Before 2025, the growth rate in free cash flow for the Magnificent Seven ran near 65% to 70%. However, for several quarters in late 2025 and early 2026, it turned slightly negative.

One example was Amazon (AMZN), the leading cloud service provider.

In 2024, analysts expected Amazon's free cash flow to be between $76 billion and $105 billion by 2026, Barron's noted. By April 2026, consensus for 2026 was $11 billion—of cash burn, or negative free cash flow. More money was expected to go out of Amazon than into the company's coffers for the year.

This reflects Amazon's massive spending on AI, which caused the company to raise its capital expenditure expectations for 2026 to $200 billion. At the same time, in its fourth-quarter 2025 earnings release, the company said it expects "strong long-term return on invested capital."

That may be true, but investors seemed doubtful, judging from Amazon shares' first-quarter 2026 performance when it dropped about 10%. Time will tell if the investment in AI brings free cash flow roaring back. This is something investors might be able to monitor by comparing sequential growth in revenue to any anticipated slowdown in capital expenditures over the coming quarters.

Meta Platforms (META), also spending heavily on AI, was downgraded by JPMorgan Chase after its first-quarter earnings report in late April 2026, pointing out that it expects Meta's capex will grow by 42% in 2027, leading to negative free cash flow of $4 billion in 2026 and $24 billion in 2027, media reports said. Shares of Meta fell 8% the day after reporting.

While sliding free cash flow can't be completely blamed for the drop, it appeared to play a role in JPMorgan's downgrade.

As investors learned in the first quarter of 2026, Wall Street is paying closer attention to free cash flow, which is reason enough for other market participants to follow suit.