Accounting for Financial Management: Free Cash Flow The focus on traditional financial statements is market data rather than cash flow. However, cash flow is important to investors, managers, and stock analysts. Therefore, decision makers and security analysts need to modify financial statement data provided to them. An important modification is the concept of free cash flow (FCF). Many analysts regard FCF as being the single and most important number that can be developed from the income statements, even more important than net income. The equation for free cash flow is: FCF = = (EBIT(1 - T) + Depreciation and amortization) - [Capital expenditures + delta Net operating working capital]
Free cash flow is the cash flow actually available for payments to all investors (stockholders and debtholders) after the company has made investments in fixed assets, new products, and operating working capital. A negative FCF means that the company does not have sufficient internal funds to finance its investments in fixed assets and working capital, and that it will have to raise new money in the capital markets to pay for these investments. Negative FCF is not always bad. If FCF is negative because after- tax operating income is negative this is bad, because the company is probably experiencing operating problems. Exceptions to this might be startup companies, companies incurring significant expenses to launch a new product line, and high-growth companies-with large capital investments.
Quantitative Problem: Rosnan Industries' 2018 and 2017 balance sheets and income statements are shown below.
Balance Sheets
Assets 2018 2017
Cash and equivalents $100 $85
Accounts receivable 275 300
Inventories 375 250
Total current assets $750 $635
Net plant and equipment 2,300 1,490
Total assets $3,050 $2,125
Liabilities and Equity
Accounts payable $150 85
Accruals 75 50
Notes payable 150 75
Total current liabilities $375 210
Long-term debt 450 290
Total liabilities 825 500
Common stock 1,225 1,225
Retained earnings 1,000 400
Common equity 2,225 1,625
Total liabilities and equity $3,050 $2,125
Income Statements
2018 2017
Sales $3,100 $1,600
Operating costs excluding
depreciation and amortization 1,250 1,000
EBITDA $1,850 $600
Depreciation and amortization 100 75
EBIT $1,750 525
Interest 62 45
EBT $1,688 $480
Taxes (40%) 675 192
Net income $1,013 $288
Dividends paid $53 48
Addition to retained earnings $600 $240
Shares outstanding 100 100
Price $25.00 $22.50
WACC 10.00%
The balance in the firm's cash and equivalents account is needed for operations and is not considered "excess" cash. Using the financial statements given above, what is Rosnan's 2018 free cash flow (FCF)?