Week 4. Free Cash Flow

Evaluation by Parts

Separating accounts with different performances, i.e. excess cash having much lower returns than operating businessto assess the overall cash flow more accurately and identify areas for improvement.

EBIT

Measures a company’s operating profit before deducting interest and taxes, includes d&a expense, and reflects a company’s ability to generate revenue

EBITA

EBIT by adding back amortization expense, to show actual intangible cost

EBITDA

adds depreciation back to EBITA, to show pure operational earnings before non-cash expense

Free Cash Flow

After-tax cash flow available to all investors (debt holders, pref stock, common equity holders, etc)

Unlevered FCF

Cash left over for all investors, before considering debt payments and it is more preferred in valuation because it focuses on the company’s core operations

Levered FCF

Cash left over only for stockholders after accounting for interest expense and interest income

Capitalizing R&D

If a company has a significant long-term R&D, do not subtract the annual R&D expense. Instead capitalize on B/S and subtract an annualized amortization

Capitalizing Operating Leases

If a company has a significant operating leases, capitalize operating leases on the B/S and add back lease-based interest to operating profit, also convert remaining rental expense to depreciation

Excluding Recognized Pension Gains and Losses

Booked on the I/S usually hidden with COGS. Remove and recognized gains or losses from NOPAT. Unrecognized gains do not flow through the I/S, so no change is required for them