Manipulation of free cash flow. NOT all FCF should be valued the same.

Because investors have become suspicious of company profits, free cash flow is a popular way to assess a share.  

Rightly, profits are too easy to manipulate.  Yet, free cash flow can be manipulated as well and you need to know how to spot this.

Companies can boost their free cash flow in many ways.  

Here are a few ways they can do this:

1.  Delay paying their bills until after the end of the financial year. 

This increases their trade creditors and boosts operating cash flow and free cash flow for the year.

2.  Sell debtors to a credit company (also known as debt factoring).   

This allows a company which sells products on credit to turn those sales into cash faster than ight have been the case.

3.  Cut back on investment.  

Slashing investment in new assets can boost free cash flow, but might harm the long-term prospects of the business.

4.  Buy businesses rather than invest in new assets.   

A standard calculation of free cash flow might ignore this.

Review FCF and its trend over at least 5 years

This is why you should review a company's free cash flow over a number of years (at least 5 years) and look at the trend.  

You need to look at what is causing the free cash flow to change, as not all free cash flow should be valued the same.

NOT all FCF should be valued the same.

1.  Highest quality of free cash flow

Ideally, a company should be generating more free cash flow because its profits are growing.  This is the highest quality of free cash flow.   

2.  Lesser quality of free cash flow

Companies that are boosting cash flows through changes in working capital (paying their bills later, collecting their debtors faster and holding less stocks of finished goods) or cutting capex might be doing the right thing, but these kind of improvements are not achievable year after year.