Free Cash Flow (FCF) = EBITDA - Capex

The net Free Cash Flow is free cash flow less interest and other financing costs and taxes.

In this approach, FCF is defined as EBITDA (earnings before depreciation, interest and taxes) less capital expenditures.

Capital expenditure encompass all capital spending, whether for maintenance or expansion and no changes in working capital are considered.

Information obtained through analysis of cash flow statement.

Through analysis of individual cashflows, investors and creditors can examine the following characteristics of a business:

1.  Whether financing is internally or externally generated.
2.  Whether the firm is able to cover all debt obligations.
3.  Whether the firm is able to afford expansion.
4.  Whether the firm is able to pay dividends.
5.  Whether the firm has financial flexibility.

http://www.invalueable.net/fs_overview.html

Financial Statements 101

Table of Contents

1. Understanding Financial Statements
2. Balance Sheet
3. Income Statement
4. Statement of Cash Flows
5. Statement of Retained Earnings
6. Intrinsic Valuation Modeler™ and Putting it all Together

Cash Flow Computation

Cash Flow Computation
The total cash flow for a period can be computed as:


Income from Operations (*see below)
+ Depreciation
- Taxes
- Capital Spending
- Increase in Working Capital
------------------------------
Total (Free) Cash Flow


Explanation:

Income from operations equals revenue minus costs and expenses and is the major source of cash.  

However, two adjustments must be made to get to actual cash inflow:

• Income from operations is before taxes are deducted, so taxes need to be subtracted here to get a corrected cash flow,
• Also, depreciation charges are included in income from operations but do not lower cash in the period, so depreciation is added back to get a corrected cash flow.

Finally, only changes (up or down) to the components of working capital (inventory, receivables, payables, etc.) in the period are part of computing cash flow.  If working capital has increased, cash is required this will need to be subtracted from total cash flow.

(Additional note:  The total cash flows used in an NPV (net present value) analysis should come from well-prepared proforma financial statements developed for the project.  The total project cash flows for a period can be computed as above.)

----

Income Statement

for the period x through y

Net Sales

- Cost of Goods Sold

-------------------------

Gross Profit

Sales & Marketing

Research & Development

General & Administrative

--------------------------

Operating Expenses

Gross Profit

- Operating Expenses

-------------------------

Income from Operations*

+ Net Interest income

- Income taxes

-------------------------

Net Income

How the Financial Statements Tell a Story: Stocks and Flows

Articulation is the way in which the statements fit together, their relationship to each other.

 

The articulation of the income statement and balance sheet is through the statement of shareholders' equity and is described by the stocks and flows relation.

 

Beginning equity
+ Comprehensive income
- Net payout to shareholders
= Ending equity

 

Balance sheets give the stock of owners' equity at a point in time. The statement of shareholders' equity explains the changes in owners' equity (the flows) between two balance sheet dates, and the income statement, corrected for other comprehensive income in the equity statement, explains the change in owners' equity that comes from adding value in operations.

 

By recognising the articulation of the financial statements, the reader of the statements understands the overall story that they tell. That story is in terms of stocks and flows. (Stocks here refere to stocks of value at a point in time). The statements track changes in stocks of cash and owners' equity (net assets).

 

----

 

Consolidated Balance Sheet of Company A (in millions)

 

February 1, 2008
Cash and cash equivalent 7764
Total shareholders' equity 3735

 

February 2, 2008
Cash and cash equivalent 9546
Total shareholders' equity 4328

 

Consolidated Statement of Income (in millions)

 

Net Revenue 61133
Total Operating expenses 8231
Operating income 3440
Investment and other income, net 387
Income tax provision 880
Net income 2947

 

 

Consolidated Statement of Cash Flows (in millions)

 

Cash flows from operating activities 3949
Cash flows from investing activities (1763)
Cash flows from investing activities (4120)
Effects of exchange changes on cash and cash equivalents 152
Net (decrease) increase in cash and cash equivalents: (1782)
Cash and cash equivalents at beginning of year 9546
Cash and cash equivalents at end of year 7764

 

Consolidated Statements of Shareholders' Equity (in millions)

 

Balances at (February 2, 2007) 4328
Net income 2947
Impact of adoption of SFAS 155 6
Cahnge in net unrealised gain on investments, net of taxes 56
Foreign currency translation adjustments 17
Change in net unrealised loss on derivative instruments, net of taxes (38)
________________________________________________
Total comprehensive income 2988 (Total of all the above)
Impact of adoption of FIN 48 (62)
Stock issuances under employee plans 153
Repurchases (4004)
Stock-based compensation expense under SFAS 123(R) 329
Tax benefit from employee stock plans 3
Balance at (February 1, 2008) 3735

 

 

----

A Summary of Accounting Relations

The Balance Sheet (in millions)

 

Assets
- Liabilities
=Shareholders' equity

 

Beginning of 2008 fiscal year:
9546 in cash
4328 in equity

 

Ending of 2008 fiscal year:
7764 in cash
3735 in equity

 

Cash decreased by 1782 
Equity decreased by 593

 

 

The Income Statement (in millions)

 

Net revenue 61133
- Cost of goods sold
= Gross margin
- Operating expenses 57693
= Operating income before interest and taxes (ebit)
- Interest expense & other incomes 387
= Income before taxes
- Income taxes 880
= Income after tax and before ordinary items
+ Extraordinary items
= Net income 2947
- Preferred dividends
= Net income available to common 2947

 

or

 

Net revenue 61133
Operating expenses 57693
Other Income & Expenses 387
Pretax Income
Taxes 880
Net Income 2947

 

 

Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement) (in millions)

 

Cash flow from operations 3949
+ Cash flow from investing -1763
+ Cash flow from financing -4120
+ Effect of exchange rate 152
= Change in cash 1782

 

Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement) (in millions)

 

Beginning equity 4328
+ Comprehensive income 2988
- Net payout 3581
= Ending equity 3735

 

Net Income 2947
+ Other comprehensive income 41
= Comprehensive income 2988

 

Dividend
+ Share repurchases 4004
= Total payout
- Share issues 153
- Others 270
= Net payout 3581

 

----

 

Comments:

 

The cash flow statement reveals that the $1782 million decrease came from a cash inflow of $3949 million in operations, less cash spent in investing of $1763 million, net cash paid out to claimants of $4120 million, and an increase in the US dollar equivalent of cash held abroad of $152 million.

 

But the main focus of the financial statements is on the change in the owners' equity during the year.

 

The Company A owners' equity decreased from $4328 million to $3735 million over the year by earning $2988 million in its business actiivities and paying out a net $3851 million ($4004 million - $153 million) to its owners (plus those other items in the equity statement $270 million).

 

The income statement indicates that the net income portion of the increase in equity from business actiivities ($2947 miillion) came from revenue from selling products and financing revenue of $61133 million, less expenses incurred in generating the revenue of $57693 million, plus investment and other income of $387 million, less taxes of $880 million.

 

So Company A began its fiscal 2009 year with the stocks in place in the 2008 balance sheet to accumulate more cash and wealth for shareholders. Fundamental analysis involves forecasting that accumulation.

 

For analysis of the fundamentals, the ability to see how the accounting relations is important in developing forecasting tools.

• Understand how the statements fit together.
• Understand how financial reporting tracks the evolution of shareholders' equity, updating stocks of equity value in the balance sheet with value added in earnings from business activities.
• And understand the accounting equations that govern each statement.

How Parts of the Financial Statements Fit Together

A Summary of Accounting Relations

The Balance Sheet

Assets
- Liabilities
=Shareholders' equity


The Income Statement

Net revenue
- Cost of goods sold
= Gross margin
- Operating expenses
= Operating income before interest and taxes (ebit)
- Interest expense
= Income before taxes
-  Income taxes
= Income after tax and before ordinary items
+ Extraordinary items
= Net income
- Preferred dividends
= Net income available to common


Cash Flow Statement (and the Articulation of the Balance Sheet and Cash Flow Statement)

Cash flow from operations
+ Cash flow from investing
+ Cash flow from financing
= Change in cash


Statement of Shareholders' Equity (and the Articulation of the Balance Sheet and Income Statement)

Beginning equity
+ Comprehensive income
- Net payout
= Ending equity

Net Income
+ Other comprehensive income
= Comprehensive income

Dividend
+ Share repurchases
= Total payout
- Share issues
= Net payout

What Is A Cash Flow Statement?

What Is A Cash Flow Statement?
by Reem Heakal (Contact Author | Biography)

Cmplementing the balance sheet and income statement, the cash flow statement (CFS), a mandatory part of a company's financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The CFS allows investors to understand how a company's operations are running, where its money is coming from, and how it is being spent. Here you will learn how the CFS is structured and how to use it as part of your analysis of a company.

 

The Structure of the CFS
The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. (To learn more about the credit crisis, read Liquidity And Toxicity: Will TARP Fix The Financial System?)

 

Cash flow is determined by looking at three components by which cash enters and leaves a company:

• core operations,
• investing and
• financing.

Analyzing an Example of a CFS


Let's take a look at this CFS sample
 

  

 

From this CFS, we can see that the cash flow for FY 2003 was $1,522,000. The bulk of the positive cash flow stems from cash earned from operations, which is a good sign for investors. It means that core operations are generating business and that there is enough money to buy new inventory. The purchasing of new equipment shows that the company has cash to invest in inventory for growth. Finally, the amount of cash available to the company should ease investors' minds regarding the notes payable, as cash is plentiful to cover that future loan expense.


Of course, not all cash flow statements look this healthy, or exhibit a positive cash flow. But a negative cash flow should not automatically raise a red flag without some further analysis. Sometimes, a negative cash flow is a result of a company's decision to expand its business at a certain point in time, which would be a good thing for the future. This is why analyzing changes in cash flow from one period to the next gives the investor a better idea of how the company is performing, and whether or not a company may be on the brink of bankruptcy or success.



Tying the CFS with the Balance Sheet and Income Statement

 

As we have already discussed, the cash flow statement is derived from the income statement and the balance sheet.

• Net earnings from the income statement is the figure from which the information on the CFS is deduced.
• As for the balance sheet, the net cash flow in the CFS from one year to the next should equal the increase or decrease of cash between the two consecutive balance sheets that apply to the period that the cash flow statement covers.

(For example, if you are calculating a cash flow for the year 2000, the balance sheets from the years 1999 and 2000 should be used.)

 

 

Conclusion

 

• A company can use a cash flow statement to predict future cash flow, which helps with matters in budgeting.
• For investors, the cash flow reflects a company's financial health: basically, the more cash available for business operations, the better.
• However, this is not a hard and fast rule. Sometimes a negative cash flow results from a company's growth strategy in the form of expanding its operations.

By adjusting earnings, revenues, assets and liabilities, the investor can get a very clear picture of what some people consider the most important aspect of a company: how much cash it generates and, particularly, how much of that cash stems from core operations.  

 

 

by Reem Heakal, (Contact Author
Biography)

 

http://www.investopedia.com/articles/04/033104.asp

 

 

 

What Is A Cash Flow Statement?

Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing,


Operations
Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company's products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations.

Cash flow is calculated by making certain adjustments to net income by adding or subtracting differences in revenue, expenses and credit transactions (appearing on the balance sheet and income statement) resulting from transactions that occur from one period to the next. These adjustments are made because non-cash items are calculated into net income (income statement) and total assets and liabilities (balance sheet). So, because not all transactions involve actual cash items, many items have to be re-evaluated when calculating cash flow from operations.

For example, depreciation is not really a cash expense; it is an amount that is deducted from the total value of an asset that has previously been accounted for. That is why it is added back into net sales for calculating cash flow. The only time income from an asset is accounted for in CFS calculations is when the asset is sold.

Changes in accounts receivable on the balance sheet from one accounting period to the next must also be reflected in cash flow. If accounts receivable decreases, this implies that more cash has entered the company from customers paying off their credit accounts - the amount by which AR has decreased is then added to net sales. If accounts receivable increase from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amounts represented in AR are revenue, they are not cash.

An increase in inventory, on the other hand, signals that a company has spent more money to purchase more raw materials. If the inventory was paid with cash, the increase in the value of inventory is deducted from net sales. A decrease in inventory would be added to net sales. If inventory was purchased on credit, an increase in accounts payable would occur on the balance sheet, and the amount of the increase from one year to the other would be added to net sales.

The same logic holds true for taxes payable, salaries payable and prepaid insurance. If something has been paid off, then the difference in the value owed from one year to the next has to be subtracted from net income. If there is an amount that is still owed, then any differences will have to be added to net earnings.


Investing
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in" for calculating cash from investing.

Financing
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.

http://www.investopedia.com/articles/04/033104.asp

Reading a Cash-flow Statement

Reading a Cash-flow Statement

The purpose of the cash-flow statement is to explain the movement in cash balances or bank overdrafts held by the business from one accounting period to the next.

What is a cash-flow statement?

Over an accounting period, the money held by a business at the bank (or its overdrafts) will have changed. The purpose of the cash-flow statement is to show the reasons for this change. The cash flow statement is the link between profit and cash balance movements. It takes you down the path from profit to cash. The figures are derived from those published in the annual accounts, and notes will explain how this derivation is arrived at.

What does a cash-flow statement not show?

In the same way that a profit and loss account does not show the cash made by the business, a cash-flow staetement does not show the profit. It is entirely possible for a loss-making business to show an increase in cash, and the other way round too.

Learn to interpret the figures

The cash-flow statement is a 'derived schedule', meaning that the figures are pulled from the profit and loss account and balance sheet statements, linking the two.

Its purpose is to analyse the reasons why the company's cash position changed over an accounting period. For example, a sharp increase in borrowings could have several explanations - such as a high level of capital expenditure, poor trading, an increase in the time taken by debtors to pay, and so on. The cash-flow statement will alert management to the reasons for this, in a way that may not be obvious merely from the profit and loss account and balance sheet.

The generally desirable situation is for the net position before financing to be positive. Even the best-run businesses will sometimes have an outflow in a period (for example in a year of high capital expenditure), but positive is usually good. This become more apparent when comparing figures over a period of time. A repeated outflow of funds over several years is usally an indication of trouble. To cover this, the company must raise new finance and/or sell off assets, which will tend to compound the problem, in the worst cases leading to failure.

Cash is critical to every business, so the management must understand where its cash is coming from and going to. The cash-flow statement gives us this information in an abbreviated form. You could argue that the whole purpose of a business is to start with one sum of money and, by applying some sort of process to it, arrive at another and higher sum, continually repeating this cycle.

COMMON MISTAKES

Confusing 'cash' and 'profit'

As mentioned previously, the most common mistake with cash-flow statements is the potential confusion between profit and cash. They are not the same!

Not understanding the terminology

It is clearly fundamental to an understanding of cash flow statements that the reader is familiar with terms like 'debtors', 'creditors', 'dividends', and so on. But more than appreciating the meaning fo the word 'debtor', it is quite easy to misunderstand the concept that, for example, an increase in debtors is a cash outflow, and equally that an increase in creditors represents an inflow of cash to the business.

Also read:
Reading a Cash-flow Statement
Reading a Profit and Loss Account
Reading a Balance Sheet
Reading an Annual Report
Yield and price/earnings ratio (P/E)