which of the following statements best describes free cash flow This is a topic that many people are looking for. star-trek-voyager.net is a channel providing useful information about learning, life, digital marketing and online courses …. it will help you have an overview and solid multi-faceted knowledge . Today, star-trek-voyager.net would like to introduce to you Free Cash Flow. Following along are instructions in the video below:
“This video. I m going to talk about free cash flow specifically what free cash cash flow is and how you would go about calculating so let s start with it so free cash flow. We re talking about cash flow. That has to do with the firm s operating decisions.
And by operating decisions. We re specifically excluding the firm s financing decisions. Okay so this is cash flow. That does not have to do with the firm s financing decisions voc.
What do mean what do we mean here. What are we talking about well. When a firm generates sales it s going to have cash from those sales typically or accounts receivable that it converts to cash in any event. The firm is generating cash otherwise it wouldn t exist and now the firm is going to reduce that cash i want to pays employees.
When it pays the electric bill and so forth. It s going to be reducing the cash that it s received so when we have that going on ultimately. We re going to get to to some amount at the bottom as we just keep taking out and deducting cash ultimately. We re going to have some some net cash flow or some cash flow.
That s left over and and what happens is that that cash flow. That s left over now..
It s going to go to two primary groups. You ve got this so we ll say this cash flow gets left over goes to you can go to lenders. That s who s going to have the first claim on it this is like a bank bondholders and so forth in the second group would be the owners of the firm. So whatever doesn t go to the lenders in terms of interest payments.
And so forth is going to end up going to the owners. And if this is a publicly traded firm then we re talking about the shareholders of the firm so ultimately the firm generates cash through sales through revenue. Then it goes ahead and pays. The employees that pays its bills and then you re left with some cash and then the firm takes that cash and it has to pay its lenders first assuming.
It has borrowed money and then whatever s left over the owners have a claim on that so when we re talking about free cash flow. What we re talking about is the cash flow. That s left over so to speak before it s distributed to lenders and owners so before any interest is paid before any dividends are paid to the owners. What s the cash flow before that happens so when we think about this we can look at it in terms of an equation that we use to calculate free cash flow.
And that might make it a little bit easier for you to understand so on the left side. We ve got free cash flow and the way we re going to calculate that we re going to start with earnings before interest and taxes okay and then we re going to multiply that by 1 minus. The tax rate. Now why are we doing this why don t we just take for example net income and so the reason that we do that don t look at net income is because we want to get the effect before any interest is paid if we just looked at net income then we re already factoring in the interest tax shield and that s something we said.
We don t we don t want to deal with because we re sending with cash flow before considerations about financing decisions or things involving lenders or the owners or any kind of financing activities at all so we re taking earnings before interest in taxes and then we re scaling that by 1 minus. The tax rate because our tax..
We re going to deduct out the cash flows from that not considering the tax shield from the interest and then we re going to add back depreciation because as you know depreciation is a non cash expense and that was something that was deducted in calculating earnings before interest in taxes. So we re going to add that we re going to add that back then we ve got to subtract out capital expenditures. Those as you know we re not expensed in terms of earnings before interest in taxes. But it was a cash flow.
So we have to go ahead and we have to back out the capex and because as we spend money on machines or equipment. That money is obviously not available to lenders and owners for distributions and then lastly. We re going to subtract and incur the increase in net working capital that took place during the period. Now we re talking about increase in net.
Working capital. Specifically. We re talking about non cash. Current assets.
Okay. So inventory. Accounts receivable those type of assets. And then we re going to subtract out the non interest bearing so we re going to subtract non interest bearing current liabilities.
Just abbreviate cl. So we re basically taking the current assets not including cash..
So whatever. The current assets are deduct cash those net current assets and then we re going to subtract out any current liabilities that are not bearing interest. So for example. Some current personal portion of long term debt would not be include even though it s a current liability.
It s a that s an interest bearing current liability. So that would not be factored into our calculation of increase in that working capital. So this is our equation that we go ahead and we use to calculate this. But let s look at an example so if i just just scroll down a little bit here.
I ve got an example so if we look at let s say a firm that manufactures bottles abc manufacturing. They make they make beer bottles so we can go ahead and calculate the free cash flow. If we have these items at the left of the screen who actually want to include all the way down there we go so we can just use our formula from above. We see here we ll just take the free cash flow is just going to be the earnings before interest in taxes times 1 minus.
The tax rate plus depreciation minus capex minus the increase in net working capital so once we know what those things are it s really kind of mechanical to go ahead and calculate this so what we re going to have is 100 times. So this is our earnings before interest in taxes times 1 minus. The tax rate and we got the tax rate is 40 percent. So times that then we re going to add back depreciation because it s a non cash expense.
So we add 15 and then we re going to subtract out the capex of 35 and then we re going to subtract the increase in net working capital of 10 and and if you go ahead and you calculate this out what you re left with is free cash flow of 30. So that s the amount of cash flow to the firm after the firm s operations..
But before considering any financing effects or de financing decisions that the firm is made now it just bears mentioning that there s an alternative an alternative way to to calculating free cash flow here. So you can also calculate free cash flow as equal to the e bit their earnings before interest in taxes times. 1 minus. The tax rate.
But instead of looking and breaking out specifically by depreciation and capex. What you can go ahead. And do is just say ok i m just going to subtract out the increase in net fixed assets. Which i ll abbreviate nfa increase in net fixed assets and then of course you still take out the increase at net working capital.
So sometimes you might have a professor gives you a problem and they don t specifically give you depreciation and capex or something. But you you have a balance sheet. You can see the change from the previous year balance sheet you can see the change in net fixed asset you can go ahead and still calculate free cash flow and so when we look at this net fixed assets what next assets is or are we re talking about gross fixed assets minus accumulated kimya i ll just abbreviate this here minus accumulated depreciation and if you calculate a free cash. Flow.
Using this this will get you to the same place as our original equation for free. ” ..
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