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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
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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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