Tag Archives | capital expenditures

Free Cash Flow Definition

See also:
Discounted Cash Flow Analysis
Valuation Methods
Free Cash Flow Analysis

Free Cash Flow Definition

The business is like a human body, the body needs blood, the business needs cash. Investor look at Free Cash Flow to make their decision for investment. Interestingly, it’s not a number you can come up easily. First, let’s look at the free cash flow definition. Many business owners, somehow, are not familiar with Free Cash Flow. The Free Cash Flow definition is cash generated by the company after deducting capital expenditures from its operating cash flow the amount of. In other words, after the company pays for employees, debts, expense, fixed assets, rent, plant, etc., whatever money you have got left (“left-over money“) is called Free Cash Flow.

FCF Example

For example, a company has $1 million cash flow from operating activities in its financial statement. However, they are spending more than $900,000 on purchasing property plants or replacing equipment. In this case, the investor will have to analyze the business to see if it was either a poor management decision or a high growth opportunity (i.e. more investment than cash on hand).

Even when a company makes positive Net Earnings, it doesn’t necessarily mean that company has Free Cash Flow.


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Why is Free Cash Flow Important?

As it mentioned above, cash keeps the business running. If your company has Free Cash Flow, then what should the company be spending the money on? They could either hire more employees, invest in other assets, issue dividends, or make more acquisition. Before you make the decision, there are 3 main reasons you would consider FCF as a competitive advantage to maintain the business growth rate.

Free Cash Flow to Equity (FCFE)

FCFE measures the Equity value, referred as “levered” cash flow. It’s the amount of money available for equity shareholders after paying all expenses, debts, reinvestment. Also, consider free cash flow to equity as an adjustment for debt cash flow.

Free Cash Flow to Firm (FCFF)

FCFF measures the enterprise value, referred to as “unlevered” cash flow. Free cash flow to firm shows available cash to all investor – both debt and equity. In an Unlevered Discounted Cash Flow analysis, you would use WACC (Weighted Average Cost of Capital).

Valuation using Free Cash Flow

Other than using DCF method (Discounted Cash Flow), use Free Cash Flow to estimate the present value of a business.

FCF = Present Value.

By calculating free cash flow, you can interpret discretionary cash flow of the company. If FCF is positive, then the company has many options where to put the money in. Whereas if FCF is negative, then you have to analyze if it’s a one-time issue or a recurring problem. If it’s constantly negative, then the company has to raise more money (debt or equity) or eventually has to restructure itself.

Free Cash Flow Formula

The free cash flow formula is very simple. Look at the Cash Flow Statement. Subtract Capital Expenditures from Operating Cash Flow.

Free Cash Flow = Cash Flow from Operation – Capital Expenditures

Operating Cash Flow

Operating cash flow is the amount of money required to fund a company’s normal operation. It’s usually in bold and always show before Financing and Investing Cash Flow. You can also refer to Operating Cash Flow as “Working Capital“.

 Capital Expenditures (CAPEX)

Find Capital Expenditures (CAPEX) in the Cash Flow Statement, under Cash Flow from Investing Activities. However, Capital Expenditures is sometimes listed as Purchase of Property & Equipment. Capital Expenditure is different from Operating Expense (OpEx).

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free cash flow definition, Free Cash Flow Formula
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Free Cash Flow Analysis

See Also:
Cash Flow Projections
Discounted Cash Flow Analysis
Cash Cycle
Steps to Track Money In and Out of a Company

Free Cash Flow Analysis Definition

Free cash flow analysis is the amount of cash that a company can put aside after it has paid all of its expenses at the end of an accounting period.

Calculation of Free Cash Flow

Free cash flow = Net cash flow from operating activities – capital expendituresdividends

Or

= Net income + amortization + depreciation + deferred taxes – capital expenditures – dividends


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Applications

Free cash flow is an important measurement of the unconstrained cash flow of the company. It measures a company’s ability to generate internal growth and to return profits to shareholders.

Positive free cash flow means that a company has done a good job of managing its cash. If free cash flow is negative then the company may have to look for other sources of funding such as issuing additional shares or debt financing.

Negative free cash flow is not necessarily an indication of a bad company, however, since many young companies put a lot of their cash into investments, which diminishes their free cash flow. But if a company is spending so much cash, it should have a good reason for doing so and it should be earning a sufficiently high rate of return on its investments.

The CEO's Guide to Improving Cash Flow


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Current Expenditures

Current Expenditures Definition

Current expenditures refer to short-term spending that is fully expensed in the fiscal period in which it is incurred. They are in contrast to capital expenditures, which refer to spending on long-term assets that are capitalized and amortized over their useful life. Examples of this type of expenditure include wages, salaries, raw material costs, and administrative expenses.

Accounting Treatment

In accounting, treat current expenditures like other short-term expenses. Fully expense them during the fiscal period they incur. Unlike capital expenditures, which are first recorded on the balance sheet as assets before hitting the income statement as amortization expenses, record current expenditures directly on the income statement as expenses in the current fiscal period. Basically, if the capital outlay is invested in an asset that will last longer than one year, then consider it a capital expenditure and treat it accordingly. On the other hand, if the capital outlay is invested in an asset that will last less than one year, then consider it a current expenditure.


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current expenditures

 

current expenditures

See Also:
Double Entry Bookkeeping
Indirect Labor
Indirect Materials
Lease Agreements
Net Operating Loss Carryback and Carryforward

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Capital Expenditures

Capital Expenditures Definition

What are capital expenditures? What is CAPEX? Capital expenditures, or CAPEX, refer to spending used to purchase or improve long-term assets, such as buildings or equipment. CAPEX are in contrast to current expenditures, which refer to spending on short-term assets. Capitalize and amortize capital expenditures over their useful life. Whereas, you expense current expenditures in the period when incurred. Also refer to CAPEX as capital outlays or capital investments.

Capital Expenditures – Accounting Treatment

In accounting, treat CAPEX differently than other types of expenses. Because a capital expenditure represents a future benefit to the company – by way of acquiring or improving a long-term asset – these expenses are capitalized, or recorded as assets on the balance sheet, and then amortized over their useful life. Basically, if a capital outlay is invested in an asset that will last longer than one year, it is considered CAPEX, and if it is invested in an asset that will last less than one year, it is considered a current expenditure. The U.S. IRS Code 263 and 263A has outlined the rules and procedures for reporting CAPEX.

capital expenditures

See Also:
Depreciation
Balance Sheet
Capital Budgeting Methods
Capital Lease Agreement
Capitalization
Cash Flow After Tax
Cash Flow Statement
Cost of Capital

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Amortization

In accounting, amortization refers to the periodic expensing of the value of an intangible asset. Similar to depreciation of tangible assets, intangible assets are typically expensed over the course of the asset’s useful life. It represents reduction in value of the intangible asset due to usage or obsolescence. Basically, intangible assets decrease in value over time, and amortization is the method of accounting for that decrease in value over the course of the asset’s useful life. A company’s long-term capital expenditures can also be amortized over time.

Amortization Treatment

Intangible assets are recorded on the balance sheet. But over time, as you amortize these assets, the amortized amount accumulates in a contra-asset account. Therefore, it diminishes the net value of the intangible assets. The periodic amortization amounts are expensed on the income statement as incurred. Whereas on the cash flow statement, these expenses are added back to net income in the operating section. This is because they represent non-cash expenses.

Intangible Asset Amortization

Examples of intangible assets that a company may amortize include the following:

Depending on the circumstances, some brand names or goodwill items may not decrease in value over time. Therefore, you may not amortize them.

Regulations

In International Financial Reporting Standards (IFRS), the rules and standards for intangible asset amortization are described in International Accounting Standard 38: Intangible Assets. In the United States, according to General Accepted Accounting Principles (GAAP), the rules and standards for intangible asset amortization are described in Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets.

Amortization of Loans

Amortizing a loan consists of spreading out the principal and interest payments over the life of the loan. Spread out the amortized loan and pay it down based on an amortization schedule or table. There are different types of this schedule, such as straight line, declining balance, annuity, and increasing balance amortization tables. Amortizing mortgages is common.

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amortization

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amortization

See Also:
Straight-Line Depreciation
Accelerated Method of Depreciation
Double Declining Method of Depreciation
Goodwill Accounting Term

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Advantages of PEO Services

See also:
How to Select a PEO
PEO Compared to Outsourcing Payroll
Professional Employer Organization FAQ’s
Step Method Allocation
Direct Method Allocation

Advantages of PEO Services

Some of the advantages of PEO Services include that the Business Owner will continue to face obstacles in Employee Benefits, Human Resources Management, Employment Practices, and Regulatory Compliance. In addition, a lack of expertise and training in these critical areas can make it difficult for consistent and timely regulatory compliance with Federal Laws, State Laws and Employment Law Court Rulings.

PEO Arrangement

The PEO arrangement is the opportunity for a Business Owner to consolidate vendors, to secure a one-stop source for payroll services, employee benefits and workers’ compensation insurance, to obtain a level of expertise often not found in-house, and to leverage the economy of scale purchasing inherent in the PEO business model.

Because a PEO does not normally require on-site workspace, while some work must take place on the company property; technological advances make communications easy and efficient which may decrease the Business Owner’s overhead expense.

Additionally, the PEO will maintain their own equipment and supplies, reducing the need for peripheral capital expenditures.

This is a time that employees are more benefit conscious. This is because Employee Benefit costs continue to rise. In addition, competitive benefit plans are becoming more difficult to find. The Business Owner and the “co-employees” will have the option to take advantage of a stable low-cost comprehensive Employee Health and Welfare Plans.

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advantages of PEO services

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