How to calculate Free Cash Flow (FCF)?


 Free Cash Flow

If you seek up Free Cash Flow in annual reports or finance courses, you will generally discover something like this:

Free Cash Flow is the portion of cash flow available for distribution to all creditors (debt or equity). That portion of the company's cash flow may be used to pay down debt or dividends to shareholders without affecting its capacity to pay its bills or investment plan.

 Calc. free cash flow.

Cash From Operating Activities (CFOA) and subtract Capital Expenditures. You can always find these data in a company's annual or quarterly cash flow statement and use them to compute Free Cash Flow. A few firms expressly discuss and compute FCF. In around half of the yearly reports I analyzed for this video, corporations reported Free Cash Flow.

Regrettably, not all firms utilize the exact definition. But, thanks to the Finance Storyteller channel, you can make sense of it all. Firms define Free Cash Flow and warnings about being mindful of when studying Free Cash Flow data in an annual report.

The following is from Facebook's yearly report on Free Cash Flow: "we define" and "we have chosen" clearly suggest that this is a non-GAAP statistic that a corporation can choose to define in a given way. 

Flow of Cash 

It's time to look at Facebook's Free Cash Flow during the last few years. The older years are on the right, and the current years are on the left. From 2011 to 2015, the net cash supplied by operational operations increased, notably in the 2013-2015 period.

As Facebook develops its capacity, the cash outflow for property and equipment increases. Facebook had a record year in Free Cash Flow: $6.1 billion! My data for the first nine months of

2016 is already more significant than the full year 2015; thus, Facebook should have another record Free Cash Flow year in 2016.

We'll look at the Free Cash Flow of three corporations later in this post: General Motors, Exxon Mobil, and General Electric.

Profit vs. FCF

So a successful firm always has a high Free Cash Flow? Unfortunately, that's not always the case. Because profitability is not the same as cash flow. Matching income and costs to the time they occur is critical to its success. When cash enters and exits, an organization is crucial from a cash flow perspective.

Let me show this with a few deals. Assume we run a modest widget factory. When we buy raw material and pay the supplier, we debit inventory and credit cash. This transaction does not affect earnings, but it does on cash flow. You record a depreciation charge if you utilize the factory's machines to produce. Depreciation is irrelevant to cash flow because you don't pay anyone for it. 

Watch the Finance Storyteller video on depreciation for more information. Credit sales income and cost of goods sold are booked when the products are delivered, and all revenue recognition conditions are met. Your margin is the gap between sales and expenses. 

This transaction does not affect cash flow because the consumer hasn't paid you yet. However, if you sell items for cash, profit and CFOA are affected. From CFOA to FCF, subtract the portion of cash flow required to support new investments or machine replacements (CapEx or Capital Expenditures).

Comparing firms' free cash flow 

It's time to compare some firms' Free Cash Flow. Please don't assume a company's financial health is good because its Free Cash Flow is high. Analyze the data, then consider the context. Here is GM's Free Cash Flow

Because the auto sector is so capital intensive, GM's Free Cash Flow is significantly smaller than Facebook's. Consider Exxon Mobil, which who created in 1870, and General Electric, founded in 1892.

Both firms are enormous multinationals that have recently restructured their business portfolios. Their FCF definitions mirror their strategic paths! Words build worlds: terms used to define strategy affect financial measures.

Like everyone else's, Exxon Mobil's concept of Free Cash Flow starts with a line called Net Cash supplied by Operating Activities. Even though this is down from 2014, it is still a massive amount at 30 billion dollars. PPE additions are generally between 30 and 35 billion per year but were only 26 billion in 2015

In other words, revenues from sales of subsidiaries, property, plant, and equipment, and sales and returns of investments. You can't keep selling sections of your business portfolio indefinitely, so handle this phrase with prudence. You'd have no corporate assets. Exxon Mobil's definition of Free Cash Flow differs from other firms in that it includes extra investments and advances, as well as a collection of passages

These appear to balance out over time. Following Exxon Mobil's definition of Free Cash Flow, the situation has altered drastically from having over $30 billion in Free Cash Flow each year in 2011-2012 to under 20% of that level at $6.5 billion in 2015. That's the difference between $100 and $30 per barrel of oil. GE is another. Their FCF has risen in recent years.

The GE definition includes cash inflows from selling property, plant, and equipment, as well as cash inflows from company dispositions. Therefore, GE's "bottom line" is Free Cash Flow plus spirits.

FCF and value

It's time to move beyond terminology and numbers to the main question: why is Free Cash Flow so important? Because analysts and investors use Free Cash Flow to assess a company's value.

 The present value equals its current cash + future free cash flow predictions discounted back (using the Weighted Average Cost of Capital). Facebook's market capitalization surpassed Exxon Mobil's and General Electric's during writing and production

Part of that is driven by the vast potential for growth in Facebook's Free Cash Flow. To estimate a company's future Free Cash Flow, you need to know not just its past performance but also its future vision, goal, and strategy, as well as its competitive environment.

 Cash Flow Recap

In summary, Free Cash Flow is a valuable non-GAAP indicator to evaluate a company's performance. Free Cash Flow does not fall from the sky like dollar dollars. Profitability requires a lot of effort. Think of it as cash flow that wants to be free.

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