I have elected free cash flow (FCF) as the most ludicrous of all cash flows.
Free cash flow sounds like an illegal donation from an unknown benefactor. But cash is never free. It is not set on finding liberty and was never in bondage. Clever accountants call it ‘unlevered free cash flow’ in an attempt to convey sophistication, with of course the relevant initials, UFCF. So, please note UFCF=FCF.
Definitions abound for FCF, with many of them quite different from one another. At times I wonder how many different types of FCF exist. The US Securities and Exchange Commission (SEC) agrees with me, but they put it more elegantly in their reply to question 102.07 of their Compliance & Disclosure Interpretations of 13th December 2022, where they state:
“However, companies should be aware that this measure (FCF) does not have a uniform definition and its title does not describe how it is calculated.”
Accordingly, they tell us, accountants using this term should give a clear description of how the measure is calculated, as well as the necessary reconciliation. Companies should also avoid inappropriate or potentially misleading inferences about its usefulness.
Definitions abound. They are so different from one another; I wonder how many different types of FCF exist. Some call it revenue available for spending, others cash not reinvested. Others say it is money from profits available to investors. I found one where it becomes an amount that remains after deducting costs and investments and another where it is, not cash, but cash flow available to equity holders after long list of deductions. Some accountants follow the advice from the SEC and list the amounts that they use to calculate their FCF. So FCF can be revenue, cash, money, ‘amount that remains’ and ‘cash flow available’ all at the same time. If this is not confusing then what is?
So what is the importance of FCF and what is it used for. There is some agreement among the specialists. In its simplest form free cash flow is used to determine the value of an enterprise. If the definition is convoluted at least this is simple.
But some companies especially in the airline industry do not use FCF for valuation purposes, they use it to trumpet their financial performance and mention FCF freely in their annual reports. And often, to maintain the level of confusion and complexity, they have two FCFs, a free cash flow and an adjusted free cash flow. In other words, they have made up their own definition for FCF which they then use to monitor their own performance. How very convenient!
But the best description of FCF comes from the title of George C Christy’s book:
‘Free Cash Flow: Seeing Through the Accounting Fog …’ [1]
FCF is an accounting fog, exactly!
[1] Free Cash Flow: Seeing Through the Accounting Fog Machine to Find Great Stocks, by George C Christy, a Wiley Finance Book, January 2009, Wiley.
