An indicator of how solvent or financially capable a company is
Free cash flow yield is important for any business, large or small, because it acts as a good metric for cash flow in comparison to the company’s size. Cash flow is always an important metric for a company, as it shows – primarily to investors – its operating performance.
What it ultimately means is that free cash flow yield acts as a positive or negative indicator of how solvent or financially capable a company is, should the need arises to access cash quickly to take care of debt, other obligations, or in the event that the company needs to be liquidated.
Free Cash Flow Yield and Market Capitalization
Free cash flow yield is calculated in comparison to the company’s size, or market capitalization, usually referenced as “market cap.” The higher the free cash flow yield is, the more the company is generating cash that can be quickly and easily accessed to satisfy its obligations.
Larger companies are often more likely to show a higher cash flow yield. However, it is not always the case. The lower the free cash flow yield, the more money investors are pumping into the company with less to show for their efforts.
Depending on the size and nature of a company, financial analysts can typically determine if certain investments are the root cause of a low cash flow yield, specifically when compared with the company’s capital expenditures.
Calculating Free Cash Flow Yield
The calculation of free cash flow yield is fairly simple. Free cash flow yield is really just the company’s free cash flow, divided by its market value.
To break it down, free cash flow yield is determined, first, by using a company’s cash flow statement, subtracting capital expenditures from all cash flow operations. Then, the free cash flow value is divided by the company’s value or market cap. It means that the formula for determining free cash flow yield looks like below:
Nearly all publicly-traded companies get their market capitalization listed on sites like Yahoo Finance and others used by financial analysts keeping tabs on company health and operations. If a company’s market cap isn’t plainly listed, it can quickly be determined by multiplying share price by outstanding shares.
What Free Cash Flow Yield Really Means to Investors
As noted above, free cash flow yield is important as a metric of operating performance. The better a company’s free cash flow yield is, the more capable and likely – both in the past and in the future – it is able to satisfy all its debts and obligations. It includes such items as dividend payouts, which are of particular importance to current equity investors.
Summary
Free cash flow yield is a valuable metric for both financial and market analysts, and especially for investors. It acts as an indicator of how capable a company can repay and make good on all of its obligations. In essence, it is a solid indicator of how financially stable a company is.
More Resources
CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:
