Analyzing the Firm’s Cash Flow

• Cash flow (as opposed to accounting “profits”) is the

primary ingredient in any financial valuation model.
• From an accounting perspective, cash flow is summarized
in a firm’s statement of cash flows.
• From a financial perspective, firms often focus on both
operating cash flow, which is used in managerial
decision-making, and free cash flow, which is closely
monitored by participants in the capital market.
Baker Corporation 2012 Income
Statement ($000)
Baker Corporation Balance
Sheets ($000)
Baker Corporation Balance
Sheets ($000)
Baker Corporation Statement of Cash Flows
($000) for the Year Ended December 31, 2012
Operating Cash Flow

• A firm’s operating Cash Flow (OCF) is the cash flow

a firm generates from normal operations—from the
production and sale of its goods and services.
• OCF may be calculated as follows:
OCF = NOPAT + Depreciation

NOPAT = EBIT - Taxes

OCF = [EBIT axes] + Depreciation

Operating Cash Flow (cont.)

• Substituting for Baker Corporation, we get:

OCF = [$370 ] + $100 = $350

• Thus, we can conclude that Baker’s operations are

generating positive operating cash flows.
Free Cash Flow

• Free cash flow (FCF) is the amount of cash flow

available to investors (creditors and owners) after
the firm has met all operating needs and paid for
investments in fixed assets and net operating
working capital.

FCF = OCF – [Change in Capital Expenditures + (Change in

Current Assets – Change in Payables and Accruals)]

Non-interest-bearing liabilities
Free Cash Flow (Asset Perspective)

• Using Baker Corporation we get:

FCF = $350 – [$300 + $0] = $50

• Also called FCF (Asset Perspective)

• The firm generated adequate cash flow to cover all of its
operating costs and investments in assets and had free
cash flow available to pay investors.
Free Cash Flow (Financing Perspective)

Interest paid $ ( 70)

Dividends paid ( 80)
Notes Payable (decrease) (100)
How was $50 paid to
Long-term Debt (increase) 200
investors?
--------
FCF (Financing Perspective) $ ( 50)

The company paid a net amount of $50 to its creditors and shareholders.
Free Cash Flow: Alternative solution

OCF = [$370  (1 – .40)] + $100 = $322

FCF = $322 – [$300 + $0] = $22

Interest net of tax [70(1-.4)] $ ( 42)

Dividends ( 80)

How was $22 paid to Notes Payable (100)

investors? Long-term Debt 200

--------
FCF (Financing Perspective) $ ( 22)

The company paid a net amount of $22 to its creditors and shareholders.
Free Cash Flow (cont.)

Cash flows from assets must always be equal to cash flows from
financing (except for the signs of the cash flows).
+(-) Cash flows from assets = -(+) Cash flows from financing

The cash flows from assets, if positive, will be the amount distributed to the

investors; if negative, it will be the amount that investors had to provide to the

firm to cover the shortage in asset free cash flows.