Free Cash Flow

One key measure that a company uses to demonstrate the financial success of its decisions is the creation of free cash flows. As you read, pay attention to the formulas used to calculate free cash flows, as shown in the example.

Free cash flow (FCF) is cash flow available for distribution among all the securities holders of an organization.

Learning Objective

  • Calculate free cash flow using all four methods.

Key Points

  • There are four different methods for calculating free cash flows.
  • Free cash flow measures the ease with which businesses can grow and pay dividends to shareholders.
  • Net income and free cash flows are different. Some investors prefer using free cash flow instead of net income to measure a company's financial performance because free cash flow is more difficult to manipulate than net income.

Terms

  • net working capital

    current assets minus current liabilities 

  • capital expenditure

    Funds spent by a company to acquire or upgrade a long-term asset.

  • amortization

    The distribution of the cost of an intangible asset, such as an intellectual property right, over the projected useful life of the asset.


In corporate finance, free cash flow (FCF) is cash flow available for distribution among all the security holders of an organization. They include equity holders, debt holders, preferred stockholders, convertible security holders, and so on. There are four different methods for calculating free cash flows.

1. Free cash flows = EBIT x (1 - Tax rate) + Depreciation & Amortization - Changes in Working Capital - Capital Expenditure

2. Free cash flows = Net profit + Interest expense - Net Capital Expenditure (CAPEX) - Net change in Working Capital - Tax shield on Interest Expense

Where Net Capital Expenditure (CAPEX) = Capex - Depreciation & Amortization and Tax Shield = Net Interest Expense X Effective Tax Rate

3. When Profit after Tax and Debt/Equity ratio (d) is available,

Free cash flows = Profit after Tax - Changes in Capital Expenditure x (1-d) + Depreciation & Amortization x (1-d) - Changes in Working Capital x (1-d)

4. Cash flows from operations = Earnings before Interest and Tax x (1-Tax rate) + Depreciation & Amortization - Changes in Working Capital

Free cash flows = Cash flows from operations - Capital Expenditure ""

Example of a Firm
   

2007

2008

2009E

2010E

2011E

2012E

2013E

CAGR(Y07/Y13)
 

EBITA

$1,995

($1,571)

$941

$2,402

$3,472

$3,655

$3,633

10.51%

(+)

Depreciation

$4,221

$4,647

$,4326

$4,145

$4,300

$4,244

$4,304

0.32%

(=)

EBITDA

$6,216

$3,706

$5,627

$6,546

$7,771

$7,899

$7,937

4.16%

(+)

CapEx

($3,976)

($3,356)

$2,163

$2,072

$2,150

$2,122

$2,152

-9.73%

(+)

CE+PF+CF

($11)

($71)

$19

$73

$1

$4

$7

N/A

(-)

Working Capital

$1,620

$1,223

$1,031

$53

$2,123

$124

$526

N/A

(+)

Investment Subsidies

$208

$300

$269

$113

$106

$62

$61

-18.49%
 

Statutory Tx Rate

26.50%

26.50%

0

0

0

0

0

0.00%

(-)

EBITA *Statutory Tax

$409

($302)

$345

$660

$961

$996

$855

13.08%

(=)

Free Cash Flow

408

-973

2,016

3,801

2,642

4,971

5,524

54.35%
 

Weight Average Cost of Capital %

8.73%

  

DCF SENSITIVITY

Assumed Perpetual Growth %

2.96%

  

Assumed Perpetual Growth %

Undiscounted Termina Value

$95,737

WACC%

2.46%

2.96%

3.46%

Net Present Value of Free Cash Flow to Enterprise

$77,315

7.73%

$4.76

$5.26

$5.89

(Net Debt)

$15.628

8.73%

$3.78

$4.11

$4.51

(Minority Interests)

$0

9.73%

$3.07

$3.30

$3.58

(Pensions and Other Financial Liabilities)

$0

 

Associate Investments

$0

STOCK OVERVIEW

Tax Assets

$0

Last Trade:

$1.70

to Fair Value

####

Equity Value

$61,687

Prev Close:

$1.70

Bid:

$1.69

Total Shares Outstanding

15,000

52wk High:

$2.00

52wk Low:

$1.43

FAIR VALUE per share

$4.11

Volume:

15,000

Avg. Vol (3m)

9,000

 

 

 

Margin of Safety and Risk Averse

20.00%

MORE INFORMATION

 

FAIR VALUE per share (adjusted)

$3.29

Market Cap%:

24.5M

Attributes:

 

 

P/E (TTM)

 

ROI (TTM)

 

P/S (TTM)

 

ROE (TTM)

 

Officers and Competitors

 

 

T. Revenue F.:

 

Net Income E:

Chairman

Mr. Christopher Anderson

 

EPS

 

EPS Est.

 

CEO | CFO

Mr. Matthew Wright

Ms. Sophia Sanchez

 

 

Smallest FCF

2.00%

Larget FCF

5.52%

Key Competitors

XTPD

XTPE

XTPF

 

 

Range FC E

3,508

Avg. FCF E:

2,791


Free Cash Flow

An example of calculating free cash flow.

Free cash flow measures the ease with which businesses can grow and pay dividends to shareholders. Even profitable businesses may have negative cash flows. Their requirement for increased financing will result in increased financing cost reducing future income.

There are two differences between net income and free cash flow. The first is the accounting for the consumption of capital goods. The net income measure uses depreciation, while the free cash flow measure uses last period's net capital purchases. The second difference is that the free cash flow measurement deducts increases in net working capital, where the net income approach does not. Some investors prefer using free cash flow instead of net income to measure a company's financial performance because free cash flow is more difficult to manipulate than net income.


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Last modified: Thursday, August 25, 2022, 5:37 PM