Free cash flow (FCF) and net income (NI) differ in the following ways:
I. net income is the return to shareholders, calculated after interest expense; free cash flow is calculated before interest.
II. net income is calculated after various non-cash expenses, including depreciation; we add back depreciation when we calculate free cash flow.
III. capital expenditures and investments in working capital do not appear in net income calculations; they do reduce free cash flows.
IV. net income is never negative; free cash flows can be negative for rapidly growing firms, even if the firm is profitable, because investments exceed cash flows from operations.
A) I only
B) I and II only
C) I, II and III only
D) I, II, III and IV

Question

Quizplus · Accepted Answer

I - Correct, net income is calculated after interest expense while FCF is calculated before interest.
II - Correct, net income includes non-cash expenses like depreciation, while we add back depreciation when calculating FCF.
III - Correct, capital expenditures and investments in working capital do not affect net income but they do reduce FCF.
IV - Correct, FCF can be negative for rapidly growing firms even with positive net income, as investments can exceed cash flows from operations.

Free Cash Flow (FCF) and Net Income (NI) Differ in the Following