Chartered Financial Analyst (CFA) Practice Exam Level 2

A key characteristic of Free Cash Flow (FCF) models is that FCF is intrinsically related to a company's profitability. Free cash flow represents the cash generated by a company that is available for distribution among all the securities holders. It is calculated as operating cash flow minus capital expenditures.

This aspect of FCF models highlights a company's ability to generate cash from its operations after accounting for the investments needed to maintain or expand its asset base. When a company's profitability is high, it typically leads to higher free cash flow, assuming capital expenditures remain constant. Thus, the relationship between FCF and profitability helps investors assess the financial health of a firm and its ability to generate cash, which is crucial for valuation and investment decisions.

Understanding this relationship is fundamental for analysts because it provides insights into how efficiently a company converts its revenue into actual cash that can be utilized for growth, debt repayment, or returning capital to shareholders.