How to Compute Free Cash Flow for Investment Banking
Virtually all investment bankers begin their analysis with the most recent period of performance of the company in question. Suppose you wanted to determine the free cash flow for IBM for the most recent year. You can go to the Securities and Exchange Commission's online EDGAR system and get the latest 10-K filing for IBM.
|For this example, the following values are provided for IBM for the year ended December 31, 2012 (amounts are in millions of dollars):Income Statement Item||Amount (In Millions of Dollars)|
|Cash flow from operations||$19,586|
|Payments for property, plant, and equipment||($4,082)|
|Proceeds from disposition of property, plant, and equipment||$410|
|Investments and business acquisitions (net)||($3,123)|
From supplemental disclosures on EDGAR, you find that IBM paid $1.022 million of interest to debt holders in 2012 and had an effective tax rate of 24 percent.
From this information, you compute free cash flow to the firm as follows:
Add the cash flow from operations to the after-tax interest.
The cash flow from operations is $19,586. The after-tax interest is $1,022 × (1 – 0.24) = $776.72, which we'll round up to $777. So, $19,586 + $777 = $20,363.
Subtract the payments for property, plant, and equipment.
Payments for property, tax, and equipment total $4,082. So, $20,363 – $4,082 = $16,281.
Add the proceeds from disposition of property, plant, and equipment.
The proceeds from disposition of property, plant, and equipment total $410. So, $16,281 + $410 = $16,691.
Subtract the investments and business acquisitions (net).
Investments and business acquisitions (net) total $3,123. So, $16,691 – $3,123 = $13,568.
So, the current free cash flow to the firm for IBM is $13,568 million, or more clearly stated, $13.6 billion. Wow, that's a lot of zeros.