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I am new to the finance space. I read the goal of a company (Philips) is to increase its free cash flow to above 2 billion euros by 2025.

I understand that free cash flow is the amount of disposable cash in a business (remaining after all expenditures. Does free cash flow = profit? And how can a company increase its free cash flow?

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Firstly, Free Cash Flow (FCF) is the cash flow from operations (which would be sales revenues and service revenues, OCF) after deducting Capital Expenditures (which are long term assets used in operations, CapEx).

So to increase free cash flow, increasing operating cash flow by selling more products or providing more services and receiving cash for it would increase operating cash flow, in turn increasing FCF assuming CapEx does not increase. Then reducing CapEx would intuitively increase FCF, but for businesses to grow and increase sales, CapEx is almost a must. Therefore, increase in CapEx would ideally lead to larger increase in OCF, then FCF would increase.

Free Cash Flow is not Profit, as profit, known as Net Income, is the net profit from revenue after deducting expenses, interest, taxes, depreciation and amortization. OCF = Net Profit + Depreciation + Amortization + Loss of PP&E - gain on PP&E - Change in Current Assets + change in Current Liabilities. Then from OCF, deduct CapEx to get FCF.

I am unsure what accounting standards Philips adheres to, so I cannot state the exact way their OCF and CapEx is derived, as under their Management Decisions & Analysis in the annual report they should provide some sort of clarification. Do note that each company has their way of classifying accounts to make their statements reflect what management wants to show, which are still in accordance to the accounting standards so long as they remain consistent every period, so the MD&A portion needs to be understood to make meaningful sense of the numbers. The above terms and equations are textbook material, which I used, from Financial Accounting, 5th Edition by Spiceland, Hermann, Thomas.

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  • $\begingroup$ Answered all questions, with textbook used included $\endgroup$ – AviatorAlpha May 18 at 12:05

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