The Calculation of Free Cash Flow

• Three methods to calculate FCF:

1. Use the sources of cash flow equation:

C - I = OI - ΔNOA
that is, free cash flow is operating income adjusted for the change in net
operating assets

2. Use the disposition of cash flows equation:

C - I = NFE - ΔNFO + d
that is, free cash flow is net financial expenses, adjusted for the change
in net financial obligations, plus dividends to common shareholders.

3. FCF can also be obtained from the reformulated Statement of Cash

Flows.

Calculation of Free Cash Flow:

Nike, Inc.: 2004
Method 1: C – I = OI - ΔΝΟΑ

Operating income 2004 $ 1,035

Net operating assets 2004 $ 4,551
Net operating assets 2003 4,330 (221)

Free cash flow 2004 $

$814

Method 2: C – I = NFE - ΔΝFO + d

Net financial expenses 2004 $ 16

Net financial obligations 2004 (289)
Net financial obligations 2003 302 591

Net dividend 2004 207

Free cash flow 2004 $814

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 Calculation of Free Cash Flow:
Reebok, 2004
Method 1: C – I = OI - ΔΝΟΑ

Operating income 2004 $ 237

Net operating assets 2004 $1,212
Net operating assets 2003 731 481

Free cash flow 2004 $ (244)

Method 2: C – I = NFE – ΔNFO + d +MI(income) -ΔMI(balance sheet)

Net financial expenses 2004 $ 18

Net financial obligations 2004 (23)
Net financial obligations 2003 (316) (293)

Net dividend 2004 23

Minority interest in income 5
Change in minority interest in
balance sheet 3
___________

Free cash flow, 2004 $ (244)

The Standard GAAP Statement of Cash Flows

Standard Statement of Cash Flows

“Cash Flow from Operations”

- “Cash Used in Investingg Activities”

+ “Cash from Financing Activities”

= Δ in Cash and Cash Equivalents

Reformulated Statement of Cash Flows

Cash flow from Operations

- Cash investments

=Free Cash Flow from Operating

Activities

Cash Paid to Shareholders

+ Cash Paid to Debtholders and Issuers

=Cash Paid for Financing Activities

This format follows the cash conservation equation:

C–I=d+F

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Indirect Method for Cash Flow from Operations

Net income
+ Accruals
= Cash from operations

Nike s statement (to follow) employs the indirect method

Nike’s
(as do almost all firms):
2004
Net income
$ 945.6 millions
Accruals
568.8
Cash provided by operations $1,514.4 millions

Nike, Inc. GAAP Statement of Cash Flows

Year Ended May 31,

2004 2003 2002
(In millions)
Cash provided (used) by operations:
Net income 945.6 474.0 663.3
Income charges not affecting cash:
Cumulative effect of accounting change - 266.1 5.0
Depreciation 252.1 239.3 223.5
Deferred income taxes 19.0 55.0 15.9
Amortization and other 58.3 23.2 48.1
Income tax benefit from exercise of stock options 47.2 12.5 13.9
Changes in certain working capital
components:
Decrease (increase) in accounts receivable 82.5 (136.3) (135.2)
(Increase) decrease in inventories (55.9) (102.8) 55.4
(Increase) decrease in prepaids and (103.5) 60.9 16.9
other current assets
Increase in accounts payable, accrued 269.1 30.1 175.4
liabilities and income taxes payable

Cash provided by operations 1,514.4 922.0 1,082.2

Cash provided (used) by investing activities:

Purchases of short-term investments (400.8) -
Additions to property, plant and (213.9) (185.9) (282.8)
equipment and other
Disposals of property, plant and equipment 11.6 14.8 15.6
Increase in other assets (53.4) (46.3) (28.7)
(Decrease) increase in other liabilities (0.9) 1.8 (6.9)
Acquisition of subsidiary, net of cash acquired (289.1) - -

Cash used by investing activities (946.5) (215.6) (302.8)

Nike, Inc. GAAP Statement of Cash Flows (cont.)

Year Ended May 31,

2004 2003 2002
(In millions)
Cash provided (used) by financing activities:
Proceeds from long-term debt issuance 153.8 90.4 329.9
Reduction in long-term debt (206.6) (55.9) (80.3)
including current portion
Decrease in notes payable (0.3) (351.1) (433.1)
Proceeds from exercise of stock options 253.6 44.2 59.5
and other stock issuances
Repurchase of stock (419.8) (196.3) (226.9)
Dividends - common and p preferred ((179.2)) ((137.8)) (
(128.9)
)
Cash used by financing activities (398.5) (606.5) (479.8)

Effect of exchange rate changes 24.6 (41.4) -28.1

Net increase in cash and equivalents 194.0 58.5 271.5

Cash and equivalents, beginning of year 634.0 575.5 304.0

Cash and equivalents, end of year $ 828.00 $ 634.00 $ 575.50

Supplemental disclosure of cash flow information:

Cash paid during the year for:
Interest, net of capitalized interest $ 37.80 $ 38.90 $ 54.20
Income taxes 418.6 330.2 262.0

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 Direct Method for Cash from Operations
Cash inflows
‐ Cash outflows
= Cash from operations
Northrop Grumman Corp.
2001 2002
Operating Activities
Sources of cash
Cash received from customers
Progress payments 3 102
3,102 1,438
1 438
Other collections 11,148 7,003
Interest received 17 17
Income tax refunds received 23 15
Other cash receipts 244 10
Cash provided by operating activities 14,534 8,483
Uses of cash
Cash paid to suppliers and employees 13,251 7,250
Interst paid 333 165
Income taxes paid 126 57
Other cash payments 7 1
Cash used in operating activities 13,717 7,473
Net cash provided by operating activities 817 1,010

Problems with the Standard Statement

1. Change in operating cash should be included in the investment
section, and the change in cash equivalents in the financing section

2. Transactions in financial assets are included in the investments

section rather than in the financing section

3. Cash interest is included in the operating

p g rather than in the
financing section

4. Tax cash flows are all included in the operating section, and not
allocated to operating and financing

5. The statement does not incorporate non‐cash transactions

1. Operating Cash and Cash in Financial

Assets: Nike

Change in cash and cash equivalents $194 million

Increase in operating cash $ 8 million

Increase in financial assets 186
$194 million

The determination of operating cash: use a normal

percentage of sales for the industry

See Nike’s reformulated balance sheet in Exhibit 9.3 in chapter 9.

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 5. Non‐cash Transactions
• Acquisitions with shares

• Asset exchanges

• Assets acquired with debt

• Capitalized leases

• Installment purchases

• Debt converted to equity

The Reformulated Statement of Cash

Flows: the Adjustments
GAAP Free Cash Flow GAAP Financing Flow

+ Net cash interest outflow (after tax) + Net cash interest outflow (after tax)

+ Investments in financial assets - Noncash financing

- Sale of financial assets + Purchase of financial assets

- Noncash investments - Sales of financial assets

- Increase in operating cash + Increase in cash equivalents
= Free Cash Flow
= Financing Cash Flow