Think of free cash flow (FCF) as another bottom line. Negative free cash flow isn't necessarily bad, but it suggests you're dealing with either a speculative investment or an underperformer. Above all, negative free cash flow usually equates to a high level of capital spending that naturally raises other questions. If the company is spending so much money on capital projects, is it at least earning a high return on that capital? Is the company’s IRR > WACC? And is all that spending paying off in rapid sales and profit growth?
The relevancy of free cash flow is that it represents “real cash,” earnings do not.
Calculation for free cash flow is as follows:
1. FCF = NOPAT – Net Investment in Operating Capital
a. NOPAT = EBIT(1-Tax Rate)
b. Net Investment in Operating Capital = [Cash + Accounts Receivable + Inventories – (Accounts Payable + Accruals)] (Net Operating Working Capital) + Operating Long-term Assets (Net Plant and Equipment)
2. FCF = (NOPAT + Depreciation) – Gross Investment in Operating Capital
a. NOPAT = EBIT(1-Tax Rate)
b. Gross Investment in Operating Capital = [(Net Operating Working Capital + Operating Long-term Assets) + (Depreciation)]
Uses of FCF
1. Pay interest to debt-holders
2. Repay debt-holders
3. Pay dividends to shareholders
4. Repurchase stock from shareholders
5. Purchase marketable securities or other non-operating assets
No comments:
Post a Comment