Not all FCFs are Created Equal?
Thanks for your answer A.L. I am still trying to get a handle on many of these issues, so please pardon my continuing questions. Anyway, for the following examples, please agree to forget about per share data for a moment and just think about absolute amounts of net income and free cash flow. (If if think about too many issues at once my eyes glaze over. <gg>) Again, let's say we have two otherwise identical companies, but company A is able to sell stock to the public and use the proceeds to contribute to $100,000 cash of the engineers $200,000 per year compensation package, with the other $100,000 per year coming from operations. Company B grants stock options to the engineers that are estimated by Black Scholes to be worth $100,000 per year, and the engineers are paid another $100,000 per year in cash from operations. Company B does not expense the stock options on their income statements provided to shareholders. Let's say that in neither case does the company buy back shares. Per share data aside, why do the absolute amounts of earnings and free cash flow look so much better for company B than company A when really $100,000 of the engineer's compensation was paid by issuing stock in both cases?
I presume the funds from selling stock to the public for company A would show up in the cash flow statement under cash flows from financing activities, but not in free cash flow. Company A would suffer an additional $100,000 per year expense per engineer on the income sheet than company B, and the absolute amount of net income and free cash flow would be $100,000 per engineer less than it would be for company B. Investors would run around praising the great performance of company B with regard to its superior net income and free cash flow, when in reality it may not be doing anything different than company A, other than issuing valuable shares to its employees instead of directly selling the shares to the public.
Now, still leaving per share data aside, let’s say company B decides to be more forthright with shareholders and begins to expense these stock options on its income statements. Ok, all of a sudden the playing field is leveled with regard to net income and expenses. Net income and expenses are now the same for company A and company B. But the playing field is not leveled with regard to free cash flow. The $100,000 per engineer that the company received for selling shares to the public is a cash expense in company A when it pays it back to the engineers, but it is not a cash expense in company B when it gives the engineers stock options worth $100,000, so when guys calculate free cash flow for company B, they add that non cash expense back in to their free cash flow number, and the absolute free cash flow for company B is still $100,000 per engineer greater than the free cash flow in company A. Company B still looks better in terms of free cash flow than company A, but in reality this looks like only an accounting nuance that is making company B appear stronger than company A.
Comments anyone? A.L.? JS? Paul Phillip? MB? Pirah? Thomas?
This one is bugging me.
Best, Huey |
