Investors are very interested in free cash flow, which is the net cash provided by operating activities minus capital expenditures and dividends. You figure free cash flow by subtracting money spent for capital expenditures, which is money to purchase or improve assets, and money paid out in dividends from net cash provided by operating activities.
Free cash flow is important to investors because, in the long run, it can have a major effect on whether the company can continue as a going concern (which means the company anticipates being in operation for at least the next 12 months).
It also has a bearing on whether investors can anticipate being paid dividends in the future and on the stability and possible increase of the market price of the stock. This consideration is important if the investor is planning to sell the stock in the near future at a price equal to or above what he originally paid for it.
The following illustrates a free cash flow calculation using our old familiar net cash provided by an operating activities figure of $115,000 and assuming capital expenditures of $45,700 and dividends of $25,000. In this calculation, free cash flow is a positive amount, which is always a good thing.
However, many users would not consider the $44,300 to be a substantial amount. One pending debt payment could eat it up entirely, leaving no free cash for other uses.
Any ratio by itself is rather meaningless unless you have some point of comparison, such as an industry average or a competitor.
About This Article
This article is from the book:
About the book author:
Maire Loughran is a certified public accountant who has prepared compilation, review, and audit reports for fifteen years. A member of the American Institute of Certified Public Accountants, she is a full adjunct professor who teaches graduate and undergraduate auditing and accounting classes.
