An improved phase generated carrier (PGC) demodulation algorithm is proposed to eliminate the effect of companion amplitude modulation in direct frequency modulation. The improved algorithm effectively eliminates the effect of companion amplitude modulation by using the third order harmonic component and the fundamental component. It reduces the generation of one mixing signal, cuts down the memory usage and the sampling frequency in the digital demodulation system. The Matlab simulation and CCS hardware emulation results verify the feasibility of the proposed algorithm.