FCF Conversion
How much of the net income on the books actually arrives as free cash flow (FCF) — a measure of earnings quality.
FCF Conversion = FCF (operating cash flow − capital expenditures) ÷ net income × 100 (trailing four quarters)
Generally, 60% or above is seen as sound, below that as something to watch, and negative as a warning.
In plain terms
Even if a company writes "we earned $10 million" on its books, not all of it lands in the bank account as cash. Sales made on credit also count as profit.
FCF conversion is the share of that book profit that actually remains as spendable spare cash (FCF). If profit is $10B and FCF is $8B, the conversion rate is 80%. It shows "how much of the book profit really turns into cash."
What it tells you
It is a yardstick for "whether this company's profit is real." A consistently high conversion rate means a healthy structure where profit comes in as cash.
Conversely, if the conversion rate is low or negative, the profit may be tied up in receivables and inventory, or recorded only on an accounting basis.
Formula
FCF Conversion = FCF (operating cash flow − capital expenditures) ÷ net income × 100 (trailing four quarters)
What high or low means
Generally, 60% or above is seen as sound, below that as something to watch, and negative as a warning. The view is that a good part of the profit earned must remain as cash for dividends, investment, and debt repayment to be possible.
During periods of heavy capital spending for growth it can dip temporarily, so a single quarter's figure and the trend tell different stories.
Looking at just one year, it swings with the timing of capital spending (the same limitation FCF has). In a year with large investment the conversion rate drops sharply, so the true quality of profit shows up only in a multi-year average.
If net income is negative or near zero, this ratio is meaningless (a small denominator makes the number jump around).
Stock given to employees (SBC) is not counted as an expense in FCF, so even if this ratio looks good, shareholders' stakes may be being diluted. Changes in share count split the portion that comes back to one share.
Metrics to read alongside
See it in real stocks
Search US stocks on Stocklore to see FCF alongside the sector benchmark.
This explanation is for information and reference only and is not a recommendation to buy or sell any security. Investment decisions and their consequences are your own.