Which formula accurately represents Free Cash Flow?

The formula for Free Cash Flow (FCF) is designed to show how much cash is available for distribution to investors after a company has funded its capital expenditures and working capital needs. The correct choice accurately reflects this calculation by incorporating several key components.

Firstly, EBIT (Earnings Before Interest and Taxes) is adjusted by subtracting taxes, which captures the cash impact of taxes on a company’s operations. This adjustment is crucial because FCF focuses on the cash generated from operations that is available to investors after tax obligations.

Next, depreciation is added back into the equation. While depreciation is a non-cash expense that reduces taxable income, it does not actually consume cash during the period. Therefore, adding it back reflects the cash that remains available from operations.

The formula then deducts capital expenditures, which are necessary investments into fixed assets like property and equipment. This deduction is essential because it reflects the cash outflows needed to maintain or expand the asset base, which is fundamental for ongoing operations and future growth.

Finally, the change in working capital is accounted for, which encompasses increases or decreases in current assets and liabilities. A positive change indicates that a company's operational cash is temporarily tied up, while a negative change suggests that cash has been freed up from operations.