How to Calculate Free Cash Flow for Investment Banking - dummies

How to Calculate Free Cash Flow for Investment Banking

By Matt Krantz, Robert R. Johnson

The statement of cash flow is a very comprehensive financial statement for investment bankers. Literally, every dollar flowing in and out of the company is counted and classified into the proper category.

But investment bankers often mix and match items from the three sections of the cash flow statement to get numbers that are most telling for them. One of the best examples of this kind of adjustment is free cash flow (FCF ). Free cash flow measures the company’s cash flow power from its core operations, after making the necessary improvements to its assets to keep the business running smoothly.

A company that doesn’t invest in keeping up its plant and equipment isn’t going to be in business for the long-term.

Free cash flow isn’t provided to you on the statement of cash flows, so if you want to analyze it, you’ll have to calculate it. Here’s how to calculate free cash flow:

  1. Start with net cash flows provided from operating activities.

    On the statement of cash flows, the last item in the section, cash flows provided from operating activities is net cash flows from operating activities. This number is net income adjusted for all the uses and sources of cash from the company’s normal operations.

  2. Subtract capital additions from net cash from operating activities.

    You’ll find capital additions from the cash flows provided by investing activities section of the cash flow statement.

  3. Analyze the findings.

    The free cash flow number gives investment bankers a good look at how much cash the company needs to keep running on an ongoing basis. It’s a good idea to do the same calculation for past periods, too, to see if the company’s cash flow usage is rising or falling over time.

If a company’s free cash flow is negative, alarm bells should go off in your head. Negative free cash flow means the business, as it currently stands, is not economically feasible over the long term.

Many Internet companies in the late 1990s and early 2000s, were propped up with easy cash financing from IPOs. But when those firms’ cash hoards disappeared, most of the companies did, too, and along with them the value of investor’s stakes in those firms.