Now calculate ABC Company's free cash flow: Change In Current Liabilities: +$80,000Ĭalculate ABC Company's operating cash flow:.The profit will also need to be adjusted for the change in working capital.ĪBC Company's financial statements show these numbers: Our first step is to calculate operating cash flow, which means that non-cash expenses, such as amortization and depreciation, that reduced net income will need to be added back. If the company doesn't disclose this elsewhere, investment analysts can attempt estimates.ĬapEx = Net increase in PP&E + Depreciation Expense FCF ExampleĪBC Company's income statement shows a net profit of $1,000,000 after taxes last year. Important Note: The Capital Expenditures line reported on a company's cash flow statement doesn't usually distinguish between maintenance capex and other growth capex. So a company that conducts, for example, $12 million of capital expenditures, but where only $5 million of that is replacing lost economic value, is effectively investing an additional $7 million in growth of its asset base. Such investments are usually in pursuit of growth for the business. Maintenance Capex versus Total Capital ExpendituresĬompanies often make capital investments that exceed the depreciated value of existing assets. However, if maintenance capex was running at only $2 million per year, it could be a sign that the company isn't replacing the full economic value of assets that have depreciated. If a given company is regularly reporting $5 million in depreciation per year, and $5 million in maintenance capex per year, it would appear that the company is sustaining a stable value of assets. However, there would have been no immediate reflection of the purchase on the company's income statement, since the value of the production line is expensed slowly, quarter after quarter, year after year, instead of being charged to the income statement in one fell swoop.ĭepreciation and Maintenance Capex are closely linked. When the hypothetical production line was purchased for $30 million, cash was paid to acquire it. Maintenance Capex (Capital Expenditure) meanwhile reflects the cash cost of purchasing new capital assets. Amortization is also a non-cash deduction on a company's income statement. However, the income statement recognizes it as a real annual cost of doing business.Īmortization is similar to depreciation, as it reflects the regular expensing of an asset that is already reflected on a company's balance sheet. This $2 million per year amount is not a cash expense, since the company paid the $30 million cash up front. For example, if a production line for electric vehicles was purchased for $30 million, and is expected to last for 15 years, the company may recognize depreciation expense of $2 million per year, until the production line is projected to have no value. This expense item reflects the assumed decrease in value for assets such as like manufacturing equipment. Calculating Free Cash Flow: Formulaįree Cash Flow = Operating Cash Flow - Maintenance Capex Maintenance Capex versus Depreciation and Amortizationĭepreciation is a common expenses reported in company's income statement. Free cash flow analysis may be used to measure the fundamental health of a company or to calculate how much the company is worth. Free cash flow can be used to pay dividends or reinvest in operations. What Is Free Cash Flow?įree cash flow (FCF) is the residual amount of cash that a business has earned from its operations, over a specific period of time, less maintenance. For example, if a company has reported an increase in Accounts Receivables, this reflects that the company has received less cash than the sales reported in the income statement would imply. Operating cashflow excludes the non-cash expenses of the income statement, but reflects other cash impacts that don't appear as income statement items, such as changes in working capital items from the balance sheet. Cashflow is cashflow, and decisions by the accounting department shouldn't affect the result. This is because CFO is less prone to the subjective application of accounting mechanisms, which can distort net income measures. Operating Cash FlowĪlthough net income is an important metric, operating cash flow, also called Cash From Operations (CFO), is believed by many to be a truer measure of profitability, especially over longer periods of time. Ridvan_celik/E+ via Getty Images Net Income vs.
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