Free cash flows

Free cash flows

Cash not required for operations or for reinvestment. Often defined as earnings before interest (often obtained from the operating income line on the income statement) less capital expenditures less the change in working capital. In terms of a formula:

Free cash flows =

Sales (Revenues from operations)
- COGS (Cost of goods sold-labor, material, book depreciation)
- SG&A (Selling, general administrative costs)
EBIT (Earnings before interest and taxes or Operating Earnings)
- Taxes (Cash taxes)
EBIAT (Earnings before interest after taxes)
+ DEP (Book depreciation)
- CAPX (Capital expenditures)
- ChgWC (Change in working capital)
C (Free cash flows)

There is an issue as to whether you want to define the FCFs to the firm as a whole (the cash flow to all of its security holders), or the FCFs only to the firm's equity holders. For firm valuation, you want the former; for stock valuation you want the latter.
To value the firm, calculate the stream of FCFs to the firm and discount this stream by the firm's WACC (Weighted average cost of capital). This will give you the value of a levered firm, including the tax benefits of debt financing. Alternatively, you can discount the firm's FCFs by its unlevered cost of capital and add separately the present value of the tax benefits.
To value the firm's equity, you can either take the above number and subtract the market value of all outstanding debt (liabilities) or you can calculate the FCFs to the firm's equity holders and discount this stream by the firm's levered equity cost of capital.
Notice that changes in working capital have the same effect on free cash flows as do changes in physical capital, i.e., capital expenditures. For example, suppose you had to spend $XX to increase the capacity of your plant. This expenditure would be a reduction in free cash flow in the year it was made. Likewise, if you had to increase the level of your cash balance, inventory or receivables by $XX to accommodate greater sales, then this too would result in a like reduction in free cash flows in the year the level of working capital was increased. [Definition and discussion courtesy of Professor Michael Bradley.]

Free Cash Flow

A measure of a company's ability to generate the cash flow necessary to maintain operations. There is more than one way to calculate free cash flow, but perhaps the simplest is to subtract a company's capital expenditures from its cash flow from operations. Some analysts believe that free cash flow is more important than other measures of financial health because it measures how much cash a company has and can make. This differs from other measures, which are sometimes accused of using both legitimate and illegitimate forms of accounting to make a company look healthier than it really is.
References in periodicals archive ?
Equity investors and short sellers also find free cash flows important when attempting to determine an entity's valuation.
Growth must be profitable to be of value, profitable enough to generate healthy free cash flows - that is, the money left over after subtracting expenses, taxes, and capital investment from revenues.
CHICAGO -- Fitch Ratings does not believe the $300 million stock repurchase program announced by Citizens Communications (Citizens) will have an effect on its credit profile due to its announced debt reduction plans and the relative near-term stability of its free cash flows.
Future free cash flows in excess of dividends will be used for general corporate purposes, which may include debt reduction, repurchase of stock or growth opportunities.
However, at this time Fitch believes CenturyTel's 'BBB+' rating and Stable Rating Outlook are still warranted, based on its expected free cash flows, existing cash on the balance sheet, moderate maturity schedule, and potential inflow of $500 million upon the conversion of the equity units in 2005.
Free cash flows during 2003 could be impacted by additional capital expenditures required to upgrade its wireless network from TDMA to a GSM platform.
free cash flows have also contributed to this effort.
UNA's covenants have been amended to provide more room and its free cash flows have improved.
Considering the company's current cash balances, free cash flows and its expected $4.
The ratings incorporate the stability and expected free cash flow generation of the company's local exchange and wireless business and the improved financial flexibility reflected in the recently amended senior secured bank facility and the capital (including the senior notes) raised by the company.
On a consolidated basis, Fitch expects BRW to generate positive free cash flow during 2003 and over the medium term.
The downgrade reflects the company's anticipated leverage and an expectation that EBITDA and free cash flow levels will continue to be pressured by moderate access line erosion and competitive impact on wireless net additions and ARPU.