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Strategies & Market Trends : Free Cash Flow as Value Criterion
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To: Pirah Naman who wrote (48)10/30/1997 9:28:00 AM
From: jbe   of 253
 
I've just had a revelation: you CAN'T "add on" changes in working capital to calculate free cash flow -- because such changes have already been included in the calculation of net operating cash flow!

The "Consolidated Statements of Cash Flows" in every 10-K lists the following items (as per SEC regulations)in calculating net operating cash flow: 1) net earnings; 2) depreciation and amortization, and 3) changes in operating assets and liabilities(i.e., working capital), broken down by accounts & other receivables; inventories; prepaid expenses and other operating assets; accounts payable, accrued expenses and other liabilities. The final item, net cash provided by operating activities, takes all of these factors into account.

The simplest method of calculating free cash flow is simply to subtract capital expenditures from net cash provided by operating activities. It beats me why the folks at GADR call this number "cash earnings", and claim that cash earnings "differ from free cash flow in that cash earnings do not account for periodic changes in working capital." Of course they don't -- you can't account for the same thing twice!

Perhaps the problem here is that GADR may be relying on concepts drawn from Ben Graham et al. But the revered fathers of security analysis were writing in the days before the SEC required all companies to file cash flow statements. Ever since 1989, however, companies have been filing such statements, in accordance with strict SEC rules, and that should make the whole task of estimating cash flows much simpler. Or do you disagree?
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