A company reports net income of $120m, depreciation and amortisation of $60m, a $30m non-cash impairment, $15m of stock compensation, a $40m rise in receivables, a $25m rise in payables and capital expenditure of $90m. Compute free cash flow and say which items are non-cash.

A company reports net income of $120m, depreciation and amortisation of $60m, a $30m non-cash impairment, $15m of stock compensation, a $40m rise in receivables, a $25m rise in payables and capital expenditure of $90m. Compute free cash flow and say which items are non-cash.

Approach: Rebuild cash from operations by adding back the non-cash charges and applying each working capital movement with the correct sign, then subtract capital expenditure.

120. Free cash flow is $120m, because cash from operations is 120 + 60 + 30 + 15 - 40 + 25, which is $210m, and subtracting capital expenditure of 90 leaves free cash flow of 210 - 90. The non-cash charges added back are depreciation and amortisation, the impairment and stock compensation. The two working capital lines move in opposite directions: receivables rising by 40 consumes cash because revenue was booked before it was collected, while payables rising by 25 releases cash because a supplier is financing the business. Stock compensation deserves care: adding it back in the cash statement is correct, and it is still a real cost to existing shareholders through dilution, so a valuation built on free cash flow with stock compensation added back and a share count held fixed counts the same benefit twice.

Follow-up: The impairment was taken on an asset the company still uses. What does that do to future depreciation, reported earnings and free cash flow?

Key concepts: free cash flow, non-cash charges, working capital, capital expenditure.