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Understanding Financial Statements Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Cash Flow Analysis

 - The effects of growth on
   cash flow and earnings

 - How free cash flow
     benefits investors

 - Don’t blame EBITDA for
    your losses
  
 - The borrowing base
    impacts cash flow and equity
 
 - The debt repayment
    schedule can predict a
    liquidity crisis
 

 

 


How free cash flow benefits investors

Free cash flow represents operating cash flow after interest, cash taxes, and normal capital expenditures. It’s the cash flow available to a business that is used for dividends, debt repayment, acquisitions or new business opportunities. Investors use free cash flow to evaluate stock prices, as an alternative to using EPS. Free cash flow accumulates and over time it increases share value.

Capital Expenditures

These are payments that are made to acquire property, plant or equipment, that have a useful life greater than the period reported. Repairs and maintenance to property and equipment that extend their lives are also capitalized. Depreciable assets are normally valued on the books at cost less a deprecation method. The deprecation expense of the asset should match its useful life or usage.

From a stock investor’s prospective, capital expenditures are netted from free cash flow, thus reducing the amount available to pay dividends or repay debt. Shareholders need to be concerned about the appropriate level of capital expenditures: the amount needed to replenish regular depreciation wear-and-tear, versus the amount needed for future growth, and the timing of such investments.

Example: Unisys - A company that survived because it properly used its free cash flow.

When Burroughs, once the number two computer manufacturer in the world, acquired Sperry for cash in 1988, the merger over-leveraged two old-line mainframe computer companies. The timing could not have been worse; the acquisition closed as the computer market was turning away from mainframes and moving towards personal computers. Over the next decade and a half, Unisys slowly reduced its debt and reconfigured its business model to an acceptable mix of services and manufacturing. Historically, the merger was probably one of the worst business decisions ever made, in terms of destroying shareholders’ value. The post acquisition management teams, however, did a beautiful job of using the company’s free cash flow to survive, and to a lesser degree, recapturing some of the destroyed equity.     

Investors make money from companies that generate free cash flow. I would be negligent by not mentioning Microsoft as the classic example of how free cash flow benefits investors.

 

 

 

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