Free Cash Flow Tutorial

The goal of this tutorial is to give the reader a firm understanding of how to properly and effectively measure business performance, thereby providing the reader with tools to make better business decisions. As you go through the tutorial, we will specifically compare a metric called Free Cash Flow with other commonly used business performance metrics, and show why Free Cash Flow is a superior business performance tool to use in measuring, and in helping to create, shareholder value.

Learning Objectives

The first part of the tutorial will begin with an examination of traditional business performance metrics, and why those metrics are flawed measures of economic value. Specifically, we will address the shortcomings of net income as a measure of business performance, as well as the shortcomings of some of the more widely used cash flow metrics found in today’s business world today.

We will then discuss the definition of Free Cash Flow, its use as an economically valid business performance measurement tool, and how it can help us view value creation within a company. Furthermore, we will see how this tool can be derived from the traditional financial statements, and how it can help us view the actual financial flows occurring within a business.

In addition, we will discuss the relationship between company market value and Free Cash Flow. In conjunction with Free Cash Flow, we will also discuss the importance of return on investment and its comparison to a company’s cost of capital in determining whether value has been created or destroyed within an organization. The latter part of the tutorial will be devoted to a discussion of how Free Cash Flow can be enhanced, as well as the specific steps necessary to derive the Free Cash Flow metric using the traditional accounting statements.