Free Cash Flow

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  What It Is:

Free cash flow (FCF) is a measure of how much cash a business generates after accounting for capital expenditures such as buildings or equipment. This cash can be used for expansion, dividends, reducing debt, or other purposes. 

How It Works/Example:

The formula for free cash flow is:

FCF = Operating Cash Flow - Capital Expenditures

The data needed to calculate a company's free cash flow is usually on its cash flow statement. For example, if Company XYZ's cash flow statement reported $15 million of cash from operations and $5 million of capital expenditures for the year, then Company XYZ's free cash flow was $15 million - $5 million = $10 million.

It is important to note that free cash flow relies heavily on the state of a company's cash from operations, which in turn is heavily influenced by the company's net income. Thus, when the company has recorded a significant amount of gains or expenses that are not directly related to the company's normal core business (a one-time gain on the sale of an asset, for example), the analyst or investor should carefully exclude those from the free cash flow calculation to get a better picture of the company's normal cash-generating ability.

Investors should also be aware that companies can influence their free cash flow by lengthening the time they take to pay the bills (thus preserving their cash), shortening the time it takes to collect what's owed to them (accelerating the receipt of cash), and putting off buying inventory (again, preserving cash). It is also important to note that companies have some leeway about what items are or are not considered capital expenditures, and the investor should be aware of this when comparing the free cash flow of different companies.

Why It Matters:

The presence of free cash flow indicates that a company has cash to expand, develop new products, buy back stock, pay dividends, or reduce its debt. High or rising free cash flow is often a sign of a healthy company that is thriving in its current environment. Furthermore, since FCF has a direct impact on the worth of a company, investors often hunt for companies that have high or improving free cash flow but undervalued share prices -- the disparity often means the share price will soon increase.

Free cash flow measures a company's ability to generate cash, which is a fundamental basis for stock pricing. This is why some people value free cash flow more than just about any other financial measure out there, including earnings per share.

http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/free-cash-flow-1000

The number the directors don't want you to find

FCF (Free Cash Flow)

You can use this FCF in the following manners, by comparing it with the EPS, DPS and Market Price per share:

1.  Compare FCF/share with EPS
e.g.  FCF/share divided by EPS = 80%.

2.  Divide FCF/share by the DPS (Dividend per share)
e.g.  FCF/share divided by DPS = 1.6x
This looks at the ability of the company to distribute dividends by looking at its free cash flow.

3.  FCF yield.
e.g.  FCF/share divided by Market share price/share = 5.3%.
Where the FCF yield is high, the investors should be attracted to the stock.

Everyone loves a bargain. But some people are willing to work harder to get it. Investors are like shoppers.

Marc Lichtenfeld, Friday, May 11th, 2012

Your Money >>> 

Finding the Best Cheap Stocks to Buy

My mother believes shopping is a sport. If it were, there’s no doubt she would be a world champion. I’d say an Olympic gold medalist, but she lost her amateur status years ago.

When my mom shops, she’s not satisfied unless she’s getting top merchandise for at least 40% off.

And like a hunter who can’t wait to brag about the 12-point buck he took, my mother will tell anyone who’ll listen about the $300 sweater she got for $80. But unlike the tales of hunters and fishermen, when it comes to my mom and shopping, the big one doesn’t get away.

Everyone loves a bargain. But some people are willing to work harder to get it. Investors are like shoppers. Some will stand in line to buy the latest hot Apple product (or stock), while others will wait patiently until the product or stock they want goes on sale.

When investors look for cheap stocks, they often concentrate on the price-to-earnings ratio (P/E). The P/E is simply the price per share divided by the past year’s earnings per share.

So in the case of Intel (Nasdaq: INTC), for example, the company earned $2.36 per share in the last 12 months. The current share price is $27.69. Divide $27.69 by $2.36 and you get a P/E of 11.7.

You can use that number to compare it to the P/E of the S&P 500 (15.3), its industry average (15.4), its historical average (17.1) or other specific stocks in its sector, to get an idea of whether the stock is cheap or pricey.

Analysts also look at forward price to earnings, which divides the price by the consensus analyst estimate for the next year. In Intel’s case, analysts project earnings of $2.49 per share in 2012, giving it a forward P/E of 11.1.

Methods better than P/E
But I believe investors pay too much attention to earnings and not enough to cash flow. You can also obtain a company’s valuation based on price to cash flow and, like P/E, compare it to industry averages, the S&P 500, etc.

Other popular valuation metrics include the price-to-sales ratio (P/S), which is the share price divided by revenue per share. If revenue per share isn’t readily available, all you do is divide the last 12 months’ sales and divide by the number of shares.

Price to book value (P/B) is also a popular tool. Book value is the value of the assets investors would get if the company were liquidated. Book value is simply shareholders’ equity (found on the balance sheet) divided by the number of shares outstanding.

Which one is more important when it comes to price performance?

Let’s take a look at each. I ran a stock screen and a corresponding backtest to measure the performance of all stocks whose valuation in each of those four metrics (separately) was below the average of its industry.

Price-to-earnings ratio
Over the past 10 years, if you bought every company (that was profitable) trading below its industry’s average P/E and held the stock for one year, you’d have outperformed the S&P 500 by 218%. In only two out of the 10 years would that formula have underperformed the market — and not by much.

A recent example is Apache Corporation (NYSE: APA), trading at 7.8 times earnings versus the average insurer at 17.8.

Price to cash flow
Testing undervalued, cheap stocks based on price-to-cash flow also turned out a stellar outcome, beating the market by 749%. It underperformed the market in three out of 10 years, but the worst year was only by 3.15%. Conversely, in six of the seven years it beat the market it did so by double digits, several times by 50% or higher.

Sprint Nextel (NYSE: S) currently trades at just 1.9 times cash flow, which is dirt cheap, even in its industry, which only trades at an average of 4.6 times cash flow, compared to the S&P 500, which is valued at 9.1 times cash flow.

Price to book value
The results were even better on stocks trading at a lower price-to-book value than their industry average. Over the 10-year period, those stocks climbed 2,193% versus the 13% of the S&P 500. These stocks beat the market every year, including by over 100% in 2009 and 2010.

A current example is NVIDIA Corporation (Nasdaq: NVDA), which trades at 1.8 times its book value, versus its industry average of 2.8.

Price-to-sales ratio
When I ran the backtest using companies whose price-to-sales ratio was below the industry average, something incredible happened. A $1,000 investment in 2001 turned into $286,535! While the same amount invested in the S&P 500 was worth $1,130.

The screen beat the S&P 500 in every year. But what was really interesting was that in 2003 and 2009, years in which the overall market recovered from steep sell-offs, the low P/S stocks went nuts. They outperformed the S&P 500 by 232% in 2003 and 745% in 2009.

Keep in mind, this involved owning a few thousand stocks, so this isn’t easily copied in real life, but it might give you a starting point the next time we start to come out of a nasty bear market.

Symantec (Nasdaq: SYMC) is a current example, trading at just 1.8 times sales versus its peers’ average of 3.8 times sales.

You obviously don’t want to run a screen, throw a dart at the list and buy a stock. You want to dig a little deeper. But by knowing which types of stocks tend to outperform the market, you increase your chances of getting a bargain that you’ll be as happy with as my mother is with a $400 designer jacket that she got for $35 (true story).

5 Companies You Can Buy Today

By Morgan Housel
July 6, 2012

There are many ways to value a company. Price to earnings. Price to cash flow. Liquidation value. Price per eyeballs on website. Price to a number I made up (this one never gets old). Price to CEO's ego divided by lobbying activity as a percentage of revenue (this one doesn't get used enough).

Which one is best? They're all limited and reliant on assumptions. No single metric holds everything you need to know.

The metric I'm using today is no different. But it's perhaps the most encompassing, and least susceptible to hidden complexities of a company's financial statements. The more I think about it, the more I feel it's one of the most useful metrics out there.

What is it? Enterprise value over unlevered free cash flow.                                                       

• Enterprise value is market capitalization (share price times shares outstanding) plus total debt and minority interests, minus cash.
• Unlevered cash flow is free cash flow with interest paid on outstanding debt added back in.

The ratio of these two statistics provides a valuation metric that takes into consideration allproviders of capital -- both stockholders and bondholders.

But you invest in common stock, so why should you care about bondholders? Ask Lehman Brothers investors why. When a company earns money, it has to take care of bondholders before you, the common shareholder, get a dime. Focusing solely on profits and equity can be misleading.

Enterprise value provides a more encompassing view. By bringing debt capital into the situation, we see real earnings in relation to the company's entire capital structure. If you owned the entire business, this is the metric you'd naturally gravitate toward.

Using this metric, here are five companies I found that look attractive.

Company	Enterprise Value/Unlevered FCF	5-Year Average	CAPS Rating (out of 5)
Google (Nasdaq: GOOG  )	18.1	35.2	****
Johnson & Johnson(NYSE: JNJ  )	19.8	21.9	*****
Procter & Gamble (NYSE:PG  )	24.6	28.4	*****
UnitedHealth Group(NYSE: UNH  )	6.9	10.2	*****
Colgate-Palmolive (NYSE:CL  )	22.8	24.4	*****

Source: S&P Capital IQ.

Let's say a few words about these companies.

Three years ago, Warren Buffett and Charlie Munger had some flattering words for Google. "Google has a huge new moat. In fact I've probably never seen such a wide moat." Munger said. "I don't know how to take it away from them," Buffett said. "Their moat is filled with sharks!" Munger added.

Here's a good example: After trying to make inroads in the online ad business, Microsoft just wrote down almost the entire value of its 2007 purchase of aQuantive. The Daily Beast summed it up well: "Microsoft's $6.2 Billion Writedown Shows It's Losing War With Google."

I still like Microsoft because it's good at what it does. But advertising and search isn't it. That's Google's turf. And today you can buy Google at literally the lowest price-to-cash-flow ratio ever. Take advantage of that while it lasts.

Johnson & Johnson is one of the best-performing stocks over the last several decades. But it's having a rough go of it lately. Recalls, management blunders, more recalls, competition from generics... and on and on. Yes, growth has slowed. Yes, it might stay slow for a while. But valuation more than compensates for that. The stock currently provides a 3.6% dividend yield, and trades for 12 times next year's earnings -- below the market average. It's a good company at a good price.

Procter & Gamble is a similar story. One of the world's greatest collections of brands has hit a slowdown. That's hit shareholder returns -- P&G shares haven't budged in two years. But most of the company's missteps appear to be tied to poor execution by management. My guess: Within a year or two the company will have a new CEO, and the market will come to appreciate its value anew.

Everything important you need to know about UnitedHealth Group comes down to the Affordable Care Act, also known as Obamacare. Most health insurance companies currently trade at depressed valuations, likely because the market hates uncertainty -- something that still exists even after the Supreme Court ruled Obamacare constitutional.

But what are the two most likely outcomes here? One is that Obamacare remains law, in which case insurers will face a raft of costly new rules, but also a flood of new customers essentially mandated to buy their product. The other is that Obamacare is repealed -- likely under a Romney administration -- in which case those costly new rules would go away. Neither outcome seems particularly bad for insurers.

Past performance is no guarantee of future returns, but I can't help but point out how successful Colgate-Palmolive has been over the last 30 years. The toothpaste and soap company has produced average returns of nearly 17% a year since 1980, compared with 11% for the broader market. That's the power of two forces: A strong brand, and simple products that aren't pushed to extinction by new technology. Combine that with a pretty reasonable valuation, and Colgate-Palmolive should be a great company to own for years to come.

http://www.fool.com/investing/general/2012/07/06/5-companies-you-can-buy-today.aspx

Telltale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.

Economies of scale:  refers to a company's ability to leverage its fixed cost infrastructure across more and more clients.

Operating leverage:  The result of economies of scale should be operating leverage, whereby profits are able to grow faster than sales.

Low ongoing capital investment to maintain their systems:

The combination of operating leverage and low ongoing capital requirements suggests that the firms should have plenty of free cash to throw around.

Telltale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.


E.g.  Technology-based businesses:  A desirable characteristic of technology-based businesses is the low ongoing capital investment to maintain their systems.  For firms already in the industry, the huge upfront technology investments have already taken place.  And the cost of technology tends to drop over time, so upkeep expenditures are minimal.  The combination of operating leverage and low ongoing capital requirements suggests that the technology-based firms should have plenty of free cash to throw around. 

Understanding Free Cash Flow (Video)

Read more: http://www.investopedia.com/video/definitions#ixzz1yiD0k3ZQ

1. 
   

   Understanding Free Cash Flow

Owner Earnings or Free Cash Flow

WARREN BUFFETT ON OWNER EARNINGS

Warren Buffett has referred to the ‘owner earnings’ of a company as the true measure of earnings. 

He has defined ‘owner earnings’ as:

Reported earnings 

+ depreciation, amortization, other non-cash items

 - average annual amount of capitalized spending on plant, machinery, equipment (and presumably research and development).

REASONING BEHIND OWNER EARNINGS

His thinking seems to go like this.

Depreciation

You should not consider depreciation because this is generally a fixed percentage of an amount spent in the past that does not necessarily reflect the true cost of replacing things when they are obsolete.

Amortization

Buffett has often criticised accounting amortisation of things such as economic goodwill. Economic goodwill, including things such as brand name, reputation, monopolistic or market dominance, might actually increase in value rather than depreciate.

Capital expenditure

It is difficult to estimate true capital spending. Items may be deferred or brought forward. Averaging actual expenditure is a more reliable guide of a company’s true capital needs.

Speculative-Growth Stocks - What Has Growth Done to the Balance Sheet?

Like most speculative-growth companies, Yahoo in 1999 doesn't generate enough cash internally to pay for an aggressive expansion.

It must look outside for capital - either by borrowing or by issuing stock in the equity markets.

Given the market's ravenous appetite for Internet stocks over the late 90s, Yahoo has understandably financed most of its expansion with equity.

It had its initial public offering in 1996, and since then it has issued stock to pay for its many acquisitions.

It has little long-term debt, which means it doesn't have to worry about interest payments.

Overall, its balance sheet looks very healthy.

In contrast, Amazon.com AMZN, another highly successful Internet company, has borrowed over $2 billion and is highly leveraged in 1999.

Speculative-Growth Stocks - Is the Business Generating Cash?

A company can make a profit without generating any cash.

• It might, for example, plow every penny that rolls through the door into inventory.  
• Or, it may slash prices in order to log sales.  Receivables will rise, but the sales won't bring in any cash.

Neither of these decisions is necessarily bad, but each raises the risk that a company will face a financial crunch.  The inventories won't sell, or a company will fail to collect on its receivables.

That;s why its often a good idea to look at cash flow in addition to earnings.

To find a company's cash flow from operations, go to its Financials Report pages.

For Yahoo, we find that its operating cash flow improved from $ -15 million in 1997 to $216 million in 1999.  That means that the company has generated even more cash than its net income indicates - generally a good sign.

If we take cash flow from operations and subtract capital spending (money spent on property, plant, and equipment), the result is free cash flow, or the cash left over after investing in the growth of the business.

Yahoo's business doesn't require a lot of capital to grow, so its capital spending has been modest.  It's free cash flow was a healthy $59 million in 1998 and $167 million 1999.  Yahoo is generating plenty of cash in those years.

Using Free Cash Flow

Company ABC.

1995  Earnings    $100,000        FCF -$7.0 million
1996  Earnings    $5.9 million      FCF -$28.0 million
1997  Earnings    $12.3 million    FCF -$57.4 million

Nice growth in earnings, right?
FCFs also grew - but in the opposite direction as earnings.

Company ABC's capital spending as a percentage of its long-term assets has been as high as 43%.  


Company OPQ.

1997  Earnings    $6,945 million     FCF  +$5,507 million
1998  Earnings    $6,068 million     FCF  +$5,634 million
1999  Earnings    $7.932 million     FCF  +$7,932 million 

Nice growth in earnings, right?
FCFs also grew - but in this case, in tandem or the same direction as earnings.

Company OPQ has an annual capital spending of $3 billion or so, and its long-term assets are about $12 billion. That spending works out to 25% of its long-term assets, a pretty high figure.   


Company DEF

1996   Earnings   $1,473 million   FCF  - $2,532million
1997   Earnings   $787 million      FCF  - $2,347 million
1998   Earnings   $  28 million      FCF  - $2,187 million

Company DEF's revenues actually declined during this period.
FCFs were consistently negative for the same period.

Company DEF spends an amount equal to about 20% of its long-term assets in a single year.


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How to use Free Cash Flow (FCF)?


Think of FCF as another bottom line.


Good and great companies generate lots of positive FCFs.


Negative FCF isn't necessarily bad, but it suggests you're dealing with either a speculative investment (such as Company ABC) or an underperformer (such as Company DEF).


Above all, negative FCF or a high level of capital spending naturally raises other questions.

1. If the company is spending so much money, is it at least earning a high premium on that capital?
2. And is all that spending paying off in rapid sales and profit growth?

If you are a careful investor, you'll want to know the answers to those questions before letting the company spend your money.

When Capital Spending Doesn't Generate Cash Flow

Company ABC.

1995  Earnings    $100,000        FCF -$7.0 million
1996  Earnings    $5.9 million      FCF -$28.0 million
1997  Earnings    $12.3 million    FCF -$57.4 million

Nice growth in earnings, right?
FCFs also grew - but in the opposite direction as earnings.

Company ABC's capital spending as a percentage of its long-term assets has been as high as 43%.  



Company OPQ.

1997  Earnings    $6,945 million     FCF  +$5,507 million
1998  Earnings    $6,068 million     FCF  +$5,634 million
1999  Earnings    $7.932 million     FCF  +$7,932 million 

Nice growth in earnings, right?
FCFs also grew - but in this case, in tandem or the same direction as earnings.

Company OPQ has an annual capital spending of $3 billion or so, and its long-term assets are about $12 billion. That spending works out to 25% of its long-term assets, a pretty high figure.  




Company DEF

1996   Earnings   $1,473 million   FCF  - $2,532million
1997   Earnings   $787 million      FCF  - $2,347 million
1998   Earnings   $  28 million      FCF  - $2,187 million

Company DEF's revenues actually declined during this period.
FCFs were consistently negative for the same period.

Company DEF spends an amount equal to about 20% of its long-term assets in a single year.


What really hurts is when a company spends aggressively but its performance stinks.

If a company is spending like mad, it had better be increasing its sales - and its profits - at a rapid rate.  

Company ABC and Company OPQ pass that test.

Company DEF doesn't.

Company DEF is a mature company and for it to generate such meager free cash flows is bad enough.

But when a company spends an amount equal to about 20% of its long-term assets in a single year, you expect to see rapid growth.  Yet, Company DEF's revenues actually declined during this period; the company's long-term record of growth is poor when you consider how much money gets plowed into the company.

Big Capital Spending and Cash Flow Can Work Together

Company ABC.

1995  Earnings    $100,000        FCF -$7.0million
1996  Earnings    $5.9million      FCF -$28.0million
1997  Earnings    $12.3million    FCF -$57.4million


Nice growth in earnings, right?
FCFs also grew - but in the opposite direction as earnings.




Company OPQ.



1997  Earnings    $6,945million     FCF  +$5,507million
1998  Earnings    $6,068million     FCF  +$5,634million
1999  Earnings    $7.932million     FCF  +$7,932million 


Nice growth in earnings, right?
FCFs also grew - but in this case, in tandem or the same direction as earnings.






Company ABC's capital spending as a percentage of its long-term assets has been as high as 43%.  


Company OPQ has an annual capital spending of $3 billion or so, and its long-term assets are about $12 billion. That spending works out to 25% of its long-term assets, a pretty high figure.  


Both Company ABC and Company OPQ spend vast sums relative to their asset bases.  However, we see a big difference when we look at their respective FCFs.

• These positive FCFs mean Company OPQ has money left over even after its large capital-spending budgets.  
• By contrast, Company ABC, must turn to investors or lenders to make up the difference.  Only by selling new shares to the public or taking out a loan can Company ABC fund its aggressive spending.

What free cash flow tells you

What free cash flow (FCF) tells us that earnings don't?

Let us have a look at Company ABC.

From 1995 through 1997, the company posted $100,000, $5.9 million, and $12.3 million in earnings.  Nice growth, right?

The company's FCF, by contrast, was negative $7.0 million, negative $28.0 million, and negative $57.4 million.  FCFs also grew - but in the opposite direction as earnings.

That's not necessarily bad.

FCF is equal to the cash a company generates minus the amount it invests.

Company ABC is investing a lot, which is why its FCFs are negative.



How much is a lot (of capital expenditure)?

A quick way to tell how quickly a company tears through money is to compare its capital spending with its long-term assets (mostly, its plant and equipment).  

While not perfect, the comparison at least gives us an idea of how aggressively a company is spending.  

Company ABC's capital spending as a percentage of its long-term assets has been as high as 43%.  That's a prolific spender.

At the opposite end of the spectrum would be company like Company XYZ, which cruises along spending an amount equal to about 5% of its long-term assets.

When you see a percentage as high as 30% or 40%, chances are you're dealing with a young company just getting on its feet.

What is Free Cash Flow (FCF)?

FCF represents the cash a firm has generated for its shareholders, after paying its expenses and investing in its growth.

FCF = Total cash flow (Earnings with noncash charges added back in)  - capital spending

FCF can be very useful in assessing a company's financial health because it strips away all the accounting assumptions built into earnings.

A company's earnings maybe high and growing, but until you look at FCF, you don't know if the company's really generated money in a given year or not.

If you're an owner, FCF is ultimately what you're interested in.  FCFs represent real cash.  Earnings do not.

The difference between Earnings and Cash - Analyze Cash Flow The Easy Way

Summary

Once you understand the importance of how cash flow is generated and reported, you can use these simple indicators to conduct an analysis on your own portfolio. 

The point is to stay away from "looking only at a firm's income statement and not the cash flow statement." 

This approach will allow you to discover how a company is managing to pay its obligations and make money for its investors.

Difference Between Earnings and Cash

At least as important as a company's profitability is its liquidity - whether or not it's taking in enough money to meet its obligations. 

Companies, after all, go bankrupt because they cannot pay their bills, not because they are unprofitable. 

The Statement of Cash Flows


Cash flow statements have three distinct sections, each of which relates to a particular component - operations, investing and financing - of a company's business activities.

1.  Cash Flow from Operations: 

-  This is the key source of a company's cash generation. 

-  It is the cash that the company produces internally as opposed to funds coming from outside investing and financing activities. 

-  In this section of the cash flow statement, net income (income statement) is adjusted for non-cash charges and the increases and decreases to working capital items - operating assets and liabilities in the balance sheet's current position.

2.  Cash Flow from Investing: 

-  For the most part, investing transactions generate cash outflows, such as capital expenditures for plant, property and equipment, business acquisitions and the purchase of investment securities. 

-  Inflows come from the sale of assets, businesses and investment securities.

-  For investors, the most important item in this category is capital expenditures. 

-  It's generally assumed that this use of cash is a prime necessity for ensuring the proper maintenance of, and additions to, a company's physical assets to support its efficient operation and competitiveness.

3.  Cash Flow from Financing: 

-  Debt and equity transactions dominate this category. 

-  Companies continuously borrow and repay debt. 

-  The issuance of stock is much less frequent. 

-  Here again, for investors, particularly income investors, the most important item is cash dividends paid. It's cash, not profits, that is used to pay dividends to shareholders.

A Simplified Approach to Cash Flow Analysis


-  A company's cash flow can be defined as the number that appears in the cash flow statement as net cash provided by operating activities, or "net operating cash flow".

-  Many financial professionals consider a company's cash flow to be the sum of its net income and depreciation (a non-cash charge in the income statement). While often coming close to net operating cash flow, this professional's short-cut can be way off the mark and investors should stick with the net operating cash flow number.

Indicators to measure investment quality of company's cash flow 


The following indicators provide a starting point for an investor to measure the investment quality of a company's cash flow:

1.  Operating Cash Flow / Net Sales: 

-  This ratio, which is expressed as a percentage of a company's net operating cash flow to its net sales, or revenue (from the income statement), tells us how many dollars of cash we get for every dollar of sales.
-  There is no exact percentage to look for but obviously, the higher the percentage the better. 

-  It should also be noted that industry and company ratios will vary widely. Investors should track this indicator's performance historically to detect significant variances from the company's average cash flow/sales relationship along with how the company's ratio compares to its peers. 

-  Also, keep an eye on how cash flow increases as sales increase; it is important that they move at a similar rate over time.

2.  (a)  Free Cash Flow: 

-  Free cash flow is often defined as net operating cash flow minus capital expenditures, which, as mentioned previously, are considered obligatory. 

- A steady, consistent generation of free cash flow is a highly favorable investment quality – so make sure to look for a company that shows steady and growing free cash flow numbers.


FCF = 
Net Operating Cash Flow - Capital Expenditures

2 (b).  Comprehensive Free Cash Flow:
-  For the sake of conservatism, you can go one step further by expanding what is included in the free cash flow number. 

-  For example, in addition to capital expenditures, you could also include dividends for the amount to be subtracted from net operating cash flow to get to get a more comprehensive sense of free cash flow. 

Comprehensive FCF 
= Net Operating Cash Flow - Capital expenditure - dividends.

-  This could then be compared to sales as was shown above.


FCF / Net Sales
Comprehensive FCF / Net Sales


-  As a practical matter, if a company has a history of dividend payments, it cannot easily suspend or eliminate them without causing shareholders some real pain. 

-  Even dividend payout reductions, while less injurious, are problematic for many shareholders. 

-  In general, the market considers dividend payments to be in the same category as capital expenditures - as necessary cash outlays.
-  But the important thing here is looking for stable levels. This shows not only the company's ability to generate cash flow but it also signals that the company should be able to continue funding its operations. 

3..  Comprehensive Free Cash Flow Coverage: 

-You can calculate a comprehensive free cash flow ratio by dividing the comprehensive free cash flow by net operating cash flow to get a percentage ratio - the higher the percentage the better.


Comprehensive FCF Coverage 
=  Comprehensive FCF / Net operating cash flow


Importance of free cash flow.


Free cash flow is an important evaluative indicator for investors. 

- It captures all the positive qualities of internally produced cash from a company's operations and subjects it to a critical use of cash - capital expenditures. 

-  If a company's cash generation passes this test in a positive way, it is in a strong position to avoid excessive borrowing, expand its business, pay dividends and to weather hard times.

-  The term "cash cow," which is applied to companies with ample free cash flow, is not a very elegant term, but it is certainly one of the more appealing investment qualities you can apply to a company with this characteristic. 



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