Class 6 Slides

FCF

FCF
FCF is composed of two parts:
1) net cash flow from operations
2) net cash flows for investing (CAPEX)

Intuitively, think of FCF as the net cash

that a company earns (CFO) that does not
have a pre-determined destination (CFI)
and therefore is available to be paid to
capital structure owners

FCF Payout Policies

May be paid out as dividends, or
accumulated within the company
Stakeholder issues
Should the company invest your FCF?

Opportunity costs?
If FCF accumulates because there are no investing
opportunities

Compare AAPL and MO

FCF Payout Policies

Apple
Dividends
Stock Repurchases
Retained

Altria
Dividends
Stock Repurchases
Retained

FCF as a Firms Strategy

Since FCF is the difference between CFO
and CFI, it can be thought of as a
measure of growth:
Negative FCF may be associated with large
CAPEX (relative to CFO), meaning the firm is
making sizable investments for (potential)
future cash flow
Positive FCF may be associated with mature
businesses with few investment options (cash
cows)

Mature vs. Growing

AT&T
FCF

Chesapeake

Payouts

FCF
2,000
0
(2,000)
(4,000)
(6,000)
(8,000)
(10,000)
(12,000)
(14,000)

Payouts

FCF evolution over time

Starbucks FCF history shows the evolution of a highgrowth company into a mature cash cow
1991 to 2000 SBUX had negative FCF
Growth phase, CFI > CFO

2000 to 2003 SBUX had positive FCF but capital was still
flowing into the company
SBUX could fund growth organically

2003 to 2008 SBUX capital started flowing out of the

company, but CAPEX still very high
FCF narrowed into 2007; SBUX hit a growth wall

2008 to present SBUX cuts CAPEX

Now a mature company, slow growth, big payouts

Company Evolution
SBUX
2,000
1,500
1,000
500
0
(500)
(1,000)

Capital Flow

CFO

CAPEX

Calculating FCF
There are 2 (really 3) methods for
calculating the FCF
Direct Method
Converts each item on the income statement item
onto cash basis
Two different procedures

Indirect Method
Reverse engineers the firms cash flows by starting
at the bottom of the income statement and working
upwards

Direct Method (1)

FCF = Sales COGS Operating
Expenses Increase in A/R Increase in
Inventory + Increase in A/P + Depreciation
Cash Operating Taxes CAPEX
The A/R, Inventory, and A/P accounts
comprise non-cash working capital

Direct Method (2)

FCF = EBITDA*(1-T) + (T)*Depreciation
Increase in A/R Increase in Inventory +
Increase in A/P CAPEX
The A/R, Inventory, and A/P accounts
comprise non-cash working capital

Indirect Method
FCF = CFO CFI
CFO = Net Income + Depreciation Increase
in A/R Increase in Inventory + Increase in
A/P + Increase in Taxes Payable + After-tax
Interest Expense
CFI = CAPEX
Unless you have a good reason for using a Direct
Method, use the Indirect Method:
Simplest and most inclusive

The method matters

What does each method include or
exclude?
Are there accounts that should be included
that are not in the typical formulation?
What about XOMs income from affiliates?
Outside of Capital IQs EBITDA

XOM has divestitures every year, but they are

not part of CAPEX, although they are the sale
of previous CAPEX purchases
Should divestitures be netted against CAPEX?

XOM Examples
The 3 methods produce very different
estimates for XOMs FCF
One possible benchmark is the cash that has
been returned to shareholders
For payouts to be sustainable, dividends +
repurchases must be less or equal to FCF

FCF is bumpy because of lumpy CAPEX

spending
Which method makes the most sense for XOM,
factoring in the accounts that may be missing?

Real FCF is Bumpy

Pro-Forma

Actual