Free cash flow and Cash and cash equivalents are, in fact, two facets of a company’s financial health. Although, at first glance, they seem to focus on the same thing – the company’s cash, they refer to two different facets of the same coin, respectively, they answer two different questions and have distinct purposes:
- Cash Flow: How much cash does my business produce?
- Available bank and cash equivalents: How much available cash does my company have now?
In this article we explore the two concepts, highlight the differences between them, and show why both are essential for properly assessing a company and its financial health.
What is Free Cash Flow (FCF)?
Free Cash Flow (FCF), or, translated, free cash flow, represents the cash that a company generates from its commercial operations, after covering the expenses necessary for operation and investments in fixed assets.
It is essentially the cash that “remains” and that the company can freely use for various operations, including:
- Payment of dividends to shareholders,
- Loans Repayment,
- Investments in development.
Unlike accounting profit, which can be influenced by accounting policies or non-cash elements, FCF is a purely financial indicator, focused exclusively on generated real liquidity.
The FCF importance is given by the fact that:
- It represents the foundation of any business valuation (e.g. DCF Model – Discounted Cash Flow),
- It measures the real performance of the business, not from an accounting profit perspective, but from a cash perspective, i.e. profit supported by real receipts,
- It reflects the company’s growth capacity without being dependent on external financing,
- It is essential in making financing, investment and profit distribution decisions.
Free Cash Flow calculation formulas (FCF)
Direct method: FCF = Operating Cash Flow – Capital Expenditure (CapEx)
Indirect method: FCF = EBITDA – CapEx – ΔWorking Capital – Income Tax (calculated on EBIT)
What is Cash on Hand and Cash Equivalents?
Unlike FCF (Free Cash Flow), cash on hand is the total amount of cash and highly liquid cash instruments held at a given time in the company: bank accounts, cash on hand or very short-term deposits. In other words, it represents the status of the money actually existing in the company, at a given time, and the most direct indicator of short-term liquidity.
The importance of bank balances and cash equivalents is given by the fact that:
- It ensures operational continuity and timely coverage of current debts: salaries, suppliers, taxes.
- It represents an indicator of liquidity and security for the daily operation of the company.
- It helps prevent cashflow blockages.
Some practical examples:
Examples with interpretation
Example 1 – FCF (direct method)
Operational flow: 900.000 lei
CapEx: 400.000 lei
→ FCF = 500.000i lei
Interpretation: The company is producing enough cash to support investments and generate surplus. A sign of financial health and attractiveness to investors.
Example2 – FCF (indirect)
EBITDA: 1.500.000 lei
CapEx: 400.000 lei
Δ Working capital: +150.000 lei
EBIT: 1.200.000 lei
Taxes (16%): 192.000 lei
→ FCF = 758.000 lei
Interpretation: The company maintains solid cash flow despite the increase in working capital. It is able to self-finance and invest in growth without resorting to debt..
Example3 – Available at the bank
Available in the accounts: 700.000 lei
Interpretation: The company has enough cash to meet its current obligations. However, cash on hand does not indicate whether cash comes from profitable activity or from exceptional, external sources (sale of assets, loans, etc.)
Free Cash Flow (FCF) versus Cash and Cash Equivalents
The essential differences between FCF and Cash Flow can be seen in this comparative table:
| Criterion | Free Cash Flow (FCF) | Available Banking and Cash Equivalents | |||
| Definition | Cash generated from operating activities, after investments in fixed assets | Cash actually held in accounts or highly liquid instruments | |||
| Main role | Evaluates self-financing and value creation capacity | Measures immediate liquidity and short-term payment capacity | |||
| Time span | Medium and long term – pursue business sustainability | Very short term – punctual liquidity situation | |||
| Man components | EBITDA, CapEx, changes in working capital, income tax | Cash on account, cash in hand, highly liquid deposits (under 3 months) | |||
| Relevance for investors | Key indicator for assessing real performance and company value | Less relevant in valuations, but important for immediate financial risk analysis | |||
| Stability | Tends to be more stable and relevant to business trends | May vary significantly depending on specific receipts/expenses | |||
| Interpretation | A consistently positive FCF indicates a business that produces sustainable cash. | A large available balance can mean healthy liquidity or inefficiency (unused cash) | |||
| Practical use | Foundation for strategic decisions: investments, dividends, debt repayment | Essential for daily management: paying salaries, suppliers, taxes, etc. | |||
| Characteristics | Free Cash Flow (FCF) | Available at the bank | |||
| Measures what | Cash generated, after investments | Cash currently held | |||
| Analysis horizon | Medium and long term | Short term | |||
| Importance in analysis | Valuation of value and profitability | Liquidity and risk assessment | |||
| Use | Strategic planning, evaluation | Current payments, cashflow management | |||
Why is it important not to confuse them?
An entrepreneur may be tempted to believe that a large balance in the account automatically means a performing company, but this is not always the case. Likewise, a temporary negative FCF may seem worrying, but in fact it may reflect strategic investments made for the company’s long-term development. For this reason, it is important to fully understand the role of each and interpret it according to what it conveys.
Conclusions
In conclusion, for a complete picture of the company’s financial health, the two indicators must be constantly in the attention and analysis of the company’s management and interpreted simultaneously: FCF – how much cash the business produces; Cash on hand – how much cash the company actually has at its disposal. While Free Cash Flow is essential to assess whether a company creates real and sustainable value, cash on hand shows the ability to operate on short term, but does not reflect operational performance.