Free cash flow equation: .... = net income + non-cash expenses - increase in working capital - capital expenditures.

• A. net income - depreciation - capex
• B. net income + non-cash expenses - increase in working capital - capital expenditures
• C. net income + cash taxes - decrease in working capital + capital expenditures
• D. cash flow from operations - capital expenditures - dividends

Answer: (B)

Free cash flow shows how much cash a business generates after it funds its asset investments. The right way to estimate it starts with net income and then adjusts for items that affect cash without changing net income. You add back non-cash expenses (like depreciation and amortization) because they reduced net income but didn’t use cash. You then subtract increases in working capital, since tying up more resources in current assets (like inventory or receivables) consumes cash. Finally, you subtract capital expenditures, which are actual cash outflows to acquire or upgrade long-term assets. So the clean form is net income plus non-cash expenses minus increase in working capital minus capital expenditures. This aligns with the standard treatment of these components.

Other options misstate these adjustments: subtracting depreciation would wrongly reduce cash flow since depreciation is a non-cash expense; using cash taxes or a decrease in working capital changes the sign or type of adjustment; starting from cash flow from operations or subtracting dividends introduces financing activity items, which aren’t part of the free cash flow calculation.