In corporate finance, free free cash flow ( FCF ) or free cash flow to the company ( FCFF ) is a way of seeing business cash flow to see what is available for distribution among all holders of securities of a corporate entity. This may be useful for parties such as shareholders, debt holders, preferred shareholders, and convertible security holders when they want to see how much cash can be taken from the company without causing problems in their operations.
Free cash flow can be calculated in various ways, depending on the audience and the data available. Common measure is to take profit before interest and tax multiplied by (1 - tax rate), add depreciation and amortization, and then subtract change in working capital and capital expenditure. Depending on the audience, a number of improvements and adjustments can also be made to try to eliminate distortion.
Free cash flow may differ from net income, as free cash flow takes into account purchases of capital goods and changes in working capital.
Video Free cash flow
Calculation
Free cash flow can be calculated as follows:
Note that the first three lines above are calculated based on the standard Cash Flow Statement.
When net profit and applicable tax rate are provided, you can also calculate it by taking:
Where
- Net Capital Expenditure (CAPEX) = Capex - Depreciation & amp; Amortization
- Tax Shield = Net Interest Rate X Marginal Tax Rate
When PAT and Debt/Equity ratios are available:
where d - is the debt/equity ratio. for example: For a 3: 4 mixture this would be 3/7.
Therefore,
Maps Free cash flow
Difference with net profit
There are two differences between net income and free cash flow. The first is accounting for the purchase of capital goods. Net income reduces depreciation, while the size of free cash flow uses net capital purchases last period.
The second difference is that the measurement of free cash flow adjusts for changes in net working capital, where the net income approach is not. Typically, in a developing company with a 30-day collection period for accounts receivable, a 30-day payout period for purchases, and a weekly payroll, it will require more working capital to finance the labor and profit components embedded in an ever-growing balance of receivables.
When a company has negative sales growth, it is likely to decrease its capital expenditure. Receivables, provided they are collected on time, will also decrease. All of this "slowdown" will appear in addition to free cash flow. However, in the long run, the slowing sales trend will eventually follow.
The definition of Free Net Cash Flow should also allow cash available to pay off the company's short-term debt. It should also consider any dividends that the company pays.
Free Net Money Flow = Cash Flow Operations - Capital Costs to maintain current operating rate - dividends - Current portion of long-term debt - Depreciation
Here, the Capex Definition should not include additional investments in new equipment. However, maintenance costs can be added.
Dividends - This will be the basic dividend that the company wants to distribute to its shareholders.
The current part of LTD - This will be the minimum debt the company should pay in order not to fail.
Depreciation - This should be issued because this will account for future investments to replace the current PPE.
If the category of net income includes income from discontinued operations and extraordinary income make sure it is not part of the Free Cash Flow.
Net of all the above provides free cash available to reinvest in operations without having to take on more debt.
Alternate formulas
FCF measure:
- operating cash flow (OCF)
- the less expenditure needed to maintain the asset (capital expenditure or "capital expenditure") but this does not include an increase in working capital.
- less interest cost.
Dalam symbol:
Where
- OCB t is the net operating profit after tax (Also known as NOPAT) during the t
- t is the company's investment during the t period including the working capital variation
Investasi hanyalah peningkatan bersih (penurunan) dalam modal perusahaan, dari akhir satu periode hingga akhir periode berikutnya:
where K t represents the capital invested by the company at the end of the t period. Increases in non-cash current assets can, or can not be reduced, depending on whether they are considered to maintain the status quo, or become investments for growth.
Free cash flow without flow (ie, cash flows before interest payments) is defined as EBITDA - CAPEX - changes in net working capital - taxes. This is a generally accepted definition. If there is a compulsory debt payment, then some analysts take advantage of free cash flow leverage, which is the same formula above, but less interest and mandatory principal payments. Unassailable cash flow (UFCF) is commonly used as the industry norm, as it allows for easy comparison of different corporate cash flows. It is also preferable to leverage cash flows when conducting analyzes to test the impact of different capital structures on firms.
The investment bankers calculate free cash flow using the following formula:
FCFF = After Noncash fee operating income (such as D & amp; A) - CAPEX - Working capital income = Free cash flow to the company (FCFF)
FCFE = Net Income Noncash costs (such as D & A) - CAPEX - Change in non-cash working capital Net lending = Free cash to equity (FCFE)
Or just:
FCFE = FCFF Loan Net - Interest * (1-t)
Usage
- Free cash flow measures the ease of which businesses can grow and pay dividends to shareholders. Even a profitable business may have negative cash flow. Their need to increase financing will result in an increase in financing costs that reduce future earnings.
- According to the discounted cash flow rating model, the intrinsic value of an enterprise is the present value of all future free cash flows, plus the cash proceeds from the final sale. The presumption is that cash flow is used to pay dividends to shareholders. Remember the things discussed below.
- Some investors prefer to use free cash flow rather than net profit to measure the company's financial performance, because free cash flow is more difficult to manipulate than net income. Problems with this assumption are detailed in cash flow and payback.
- The payment rate is the metric used to evaluate the sustainability of the distribution of REITs, Royalty Trust of Oil and Gas, and Income Trust. Distribution is divided by free cash flow. Distributions may include income, capital gains flowing, or payback.
Issues with capital expenditure
- Spending on asset maintenance is only part of the capital expenditure reported in the Cash Flow Statement. It must be separated from expenditure for growth purposes. This split is not a requirement under GAAP, and is not audited. Management is free to disclose capital expenditure maintenance or not. Therefore, this input for free cash flow calculations may be subject to manipulation, or require estimation. Because of the large amounts, the uncertainty of capex spending is the basis for the dismissal of some people against 'free cash flow'.
- The second problem with maintenance capex measurement is its intrinsic "curvature". By its nature, spending on capital assets that will last for decades may be rare, but costly when it occurs. 'Free cash flow', in turn, will vary greatly from year to year. No particular year will be the 'norm' that can be expected to be repeated. For companies with stable capital expenditures, free cash flow will (in the long run) be approximately equal to income
Agency costs
In a 1986 paper on American Economic Review Michael Jensen notes that free cash flow allows corporate managers to finance low-income projects which, therefore, may not be funded by equity markets or bonds. Examining the US oil industry, which had gained substantial free cash flows in the 1970s and early 1980s, he wrote that:
The 1984 cash flow of the top ten oil companies was $ 48.5 billion, 28 percent of the total cash flows from the top 200 companies in the Dun Business Month survey. Consistent with the agency costs of free cash flow, management does not pay any excess resources to shareholders. Instead, the industry continues to spend a lot on [exploration and development] activities even though the average return is below the cost of capital.
Jensen also noted a negative correlation between the exploration announcements and market valuations of these companies - an effect that is contrary to the announcement of research in other industries.
See also
- Business ratings
- Discounted cash flow
- Corporate value
- Economical added value
- Owner earnings
- Weighted average capital cost
References
-
, Richard A.; Myers, Stewart C.; Allen, Franklin (2005). Company Finance Principles (8th ed.). Boston: McGraw-Hill/Irwin. ISBN: 0-07-295723-9. - Jensen, Michael C. (1986). "Cost of free cash flow agency, corporate finance and takeover". American Economic Review . 76 (2): 323-329. doi: 10.2139/ssrn.99580.
- Stewart, G. Bennett, III (1991). Search for Value . New York: HarperBusiness. ISBN 0-88730-418-4.
External links
- Free Cash Flow: Free, But Not Always Easy, Investopedia
- What is Free Cash Flow ?, Morningstar
Source of the article : Wikipedia
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