For those good at calculating free cash flows
So free cash flow to equity is typically just cash flow from ops less capex (I guess some people include debt issued and repaid here as well), and free cash flow to the firm excludes interest expense but is similar.
Let's say a company issued either debt or equity in a year and used the cash to purchase inventory. In this case, when people calculate change in working capital, inventory rises, suggesting lower cash from ops and lower FCF, but this expenditure on inventory was of course funded by the cash from the financing that probably wasn't captured in the FCF calculation. What am I missing here?
Also, why do people talk about working capital (as opposed to all assets and liabilities) almost exclusively in these calcs? If I have goodwill impairment or a writedown in one of my long-term investments (that is, any non-cash change in existing assets), that will get backed out in the cash flow from operations calculation, fine. But if I'm trying to calculate FCF by starting from net income and adjusting for changes in WC (as well as capex and D&A of course), then I won't capture these changes in long-term assets, right?
Thanks for any light people can shed to clear up my ignorance.
I've never seen anyone use debt or equity issuance in FCF.
Impairments in long-term assets would be added back in cash flow from operations. Net Income + Non-cash charges + Change in WC.
Right, so let's say you ignore debt issuance. But it turns out a company actually issued $1bn of debt to purchase inventory during a quarter. Your FCF will be reduced according to the equation by $1bn because inventory went up, which increased WC. What do you have that offsets this? Obviously this is an extreme example but you can imagine it happening with a few million bucks every few quarters.
nothing would "offset" this per say. if you issued $1bn in debt and immediately tied it up in inventory, it'd be pretty obvious when you compare funds from operations (net income + non cash items) with cash from operations (net income + non cash items + wc change). fcf is fcf - that said, if there were a huge swing like the one you've described, i'd recommend footnoting it.
it wouldn't change your cash on hand, so it'd be a wash on the cash flow statement.
Think of it this way: if the business's operation requires that $1bn inventory is purchased (for whatever reason), then it should be looked at as an outflow for FCF.
For your second question, changes in long-term assets and liabilities that are cash-related should be included in FCF if they are a part of operations. So thinks like non-current accrued expenses, deferred revenue, prepaid expenses, etc. should be accounted for in your cash flow, so long as they aren't one-time irregularities.
Let's say a company issued either debt or equity in a year and used the cash to purchase inventory. In this case, when people calculate change in working capital, inventory rises, suggesting lower cash from ops and lower FCF, but this expenditure on inventory was of course funded by the cash from the financing that probably wasn't captured in the FCF calculation. What am I missing here?
--A company that needs to raise capital to purchase inventory is worth less than a company that does not need to, so FCF should be lower to reflect that. Alternatively, the same company that makes the inventory purchase will presumably monetize it in the future, leading to higher future FCF than the company that does not make the purchase. The financing activities of a company (disregarding taxes for the moment) are not factored in for UCFC/valuation since TEV already reflects any negative UCFC which require financing plugs - i.e. discounting cash flow inherently assumes a going concern; if the company did not finance the negative UCFC, its value would not be the implied TEV.
Also, why do people talk about working capital (as opposed to all assets and liabilities) almost exclusively in these calcs? If I have goodwill impairment or a writedown in one of my long-term investments (that is, any non-cash change in existing assets), that will get backed out in the cash flow from operations calculation, fine. But if I'm trying to calculate FCF by starting from net income and adjusting for changes in WC (as well as capex and D&A of course), then I won't capture these changes in long-term assets, right?
--As Downtown mentioned above, non-current operations-related line items should be included in FCF and should exclude one-time charges. Working capital is only a part of the equation, but helps remind people that is not all assets and liabilities, since using all would get you the cash flow statement - i.e. includes financing. I personally think the simplest way to think about UCFC is cash flow statement down to cash flow from investing, excluding interest and related tax and one-time items.
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