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Breaking Into Wall Street - The 3 Financial Statements

($ in Thousands)
Tax Rate:

40.0%

Income Statement:
Revenue:
Cost of Goods Sold (COGS):
Gross Profit:
Gross Margin %:

Balance Sheet:
$

Operating Expenses:
Sales & Marketing:
Research & Development:
General & Administrative:
Total Operating Expenses:

165
75
50
290

Depreciation:
Amortization of Intangible Assets:
Stock-Based Compensation:

10
10
20

Operating Income (EBIT):


Operating Margin:

300
42.9%

Other Income / (Expenses):


Interest Income / (Expense):
Goodwill Impairment:
PP&E Write-Down:
Gains / (Losses) on Investment Sales:

20
(20)
(50)
(10)
(15)

Pre-Tax Income (EBT):

225

Income Taxes:
Current Portion:
Deferred Portion:
Net Income (Profit After Taxes):
Net Income Margin:

700
70
630
90.0%

90
40
50
$

135
19.3%

Assets:
Current Assets:
Cash:
Short-Term Investments:
Accounts Receivable:
Inventory:
Prepaid Expenses:
Total Current Assets:
Long-Term Assets:
Property, Plant & Equipment:
Goodwill:
Other Intangible Assets:
Long-Term Investments:
Total Long-Term Assets:
Total Assets:
Liabilities & Equity:
Current Liabilities:
Revolver (Short-Term Debt):
Accounts Payable:
Accrued Expenses:
Deferred Revenue:
Total Current Liabilities:
Long-Term Liabilities:
Debt:
Deferred Tax Liability:
Total Long-Term Liabilities:

Equity:
Common Stock & Additional Pa
Retained Earnings:
Treasury Stock:
Accumulated Other Comprehen
Total Equity:
Total Liabilities & Equity:

BALANCE CHECK:

Table of Contents for This Lesson:


1. What Free Cash Flow (FCF) is, and Why It's Important.
2. What if FCF is positive? What does that mean, and what do you do with it?
3. What if FCF is negative? What does it tell you about the company's operations?

4. Why do you exclude certain items, such as investing and financing activities, from the FCF c
5. How do you use and interpret FCF when analyzing and valuing companies?
6. FCF Comparison and Interpretation for Wal-Mart, Amazon, and Salesforce.
7. Recap and Summary.

What is "Free Cash Flow" and Why Does It Matter?

Start of
Period

End of
Period

nt Assets:
$

ort-Term Investments:
counts Receivable:

paid Expenses:
Current Assets:

Term Assets:
perty, Plant & Equipment:

her Intangible Assets:


ng-Term Investments:
Long-Term Assets:

s & Equity:
nt Liabilities:
volver (Short-Term Debt):
counts Payable:
crued Expenses:
ferred Revenue:
Current Liabilities:

300
300

660
50
30
30
770

100
50
150

30
50
40
100
220

450 $

990

50
15
10
15
90

Term Liabilities:
-

240
50
290

50
400
450 $

170
485
(50)
5
610

450 $

990

ferred Tax Liability:


Long-Term Liabilities:

mmon Stock & Additional Paid-In Capital:


ained Earnings:
asury Stock:
cumulated Other Comprehensive Income:

Liabilities & Equity:

Cash Flow Statement:

Cash Flow from Operating Activitie


Net Income:
Depreciation:
Amortization of Intangible Assets:
Stock-Based Compensation:
Goodwill Impairment:
PP&E Write-Down:
Deferred Income Taxes:
(Gains) / Losses on Investment Sales
Change in Operating Assets & Liab
Change in Accounts Receivable:
Change in Inventory:
Change in Prepaid Expenses:
Change in Accounts Payable:
Change in Accrued Expenses:
Change in Deferred Revenue:
Cash Flow from Operations:

Cash Flow from Investing Activities


Capital Expenditures (CapEx):
Purchases of Short-Term Investment
Purchases of Long-Term Investments
Proceeds from ST Investment Sales:
Cash Flow from Investing:

Cash Flow from Financing Activities


Debt Raised:
Debt Principal Repayment:
Revolver Issued / (Repaid):
Equity Issuance:
Dividends Issued:
Share Repurchases:
Cash Flow from Financing:
FX Rate Effects:
Net Change in Cash:
Beginning Cash Balance:

Ending Cash Balance:

NCE CHECK:

OK!

OK!
Free Cash Flow:

do with it?

ny's operations?

ing activities, from the FCF calculation?

ompanies?

nd Salesforce.

low Statement:

low from Operating Activities:


$

reciation:
ortization of Intangible Assets:
ck-Based Compensation:
dwill Impairment:
E Write-Down:
erred Income Taxes:
ns) / Losses on Investment Sales:
e in Operating Assets & Liabilities:
nge in Accounts Receivable:
nge in Inventory:
nge in Prepaid Expenses:
nge in Accounts Payable:
nge in Accrued Expenses:
nge in Deferred Revenue:
Cash Flow from Operations:
$

low from Investing Activities:


ital Expenditures (CapEx):
chases of Short-Term Investments:
chases of Long-Term Investments:
ceeds from ST Investment Sales:
Cash Flow from Investing:

135
10
10
20
50
10
50
15
(50)
(30)
(30)
15
10
15
230

(50)
(100)
(100)
85
(165)

low from Financing Activities:

t Principal Repayment:
olver Issued / (Repaid):
ity Issuance:
dends Issued:
re Repurchases:
Cash Flow from Financing:

e Effects:

ange in Cash:

ning Cash Balance:

300
(60)
50
100
(50)
(50)
290
5

360

300

g Cash Balance:

ash Flow:

660

180

What Does Free Cash Flow Mean? Wal-Mart vs. Amazon vs. Salesforce
($ in Million Except Per Share Data)
Wal-Mart - FCF Excerpt from Financial Statements:
Free Cash Flow Calculation:
Cash Flow from Operations:
Less: Capital Expenditures:
Free Cash Flow:

$
$

23,643 $
(12,699)
10,944 $

Changes In Certain Assets and Liabilities:


Accounts Receivable:
Inventories:
Accounts Payable:
Accrued Liabilities:
Accrued Taxes:
Net Change in (Operating) Working Capital:
Annual Revenue:
Annual Net Income:

421,395
16,993

Net Change as a % of Revenue:


Net Change as a % of Net Income:

Year 1
24,255 $
(13,510)
10,745 $

Year 2
25,591
(12,898)
12,693

Year 1
(796) $
(3,727)
2,687
(935)
994
(1,777)

Year 2
(614)
(2,759)
1,061
271
981
(1,060)

446,509
16,387

468,651
17,756

(0.4%)
(10.8%)

(0.2%)
(6.0%)

Free Cash Flow Growth Rate:


CapEx as a % of Cash Flow from Operations:
CapEx as a % of Revenue:

(1.8%)
55.7%
3.0%

18.1%
50.4%
2.8%

Revenue Growth Rate:


Net Income Growth Rate:
Cash Flow from Operations Growth Rate:

6.0%
(3.6%)
2.6%

5.0%
8.4%
5.5%

Interpretation: FCF seems to be all over the place - falling, rising, falling again Cash Flow from
was MOSTLY growing except for the decline in Year 3 - due to Accrued Taxes.

Revenue is certainly growing over time, but WC and CapEx impact FCF in a huge, unpredictable w
Not exactly "playing games" with Working Capital, but it did change something significantly in
Year 2, which pushed down its overall requirements even as revenue increased.
So, bottom-line: not the worst we've seen, but it's hard to buy into organic sales growth alone
contributing to the growth in Free Cash Flow. Some contribution, but some of it was also due
to CapEx and Working Capital changes.

Recap: So What Does Free Cash Flow Mean?


Roughly, Cash Flow from Operations minus CapEx.
"Discretionary cash flow" - after paying for what's required, how much does the company have
left for other uses?
Paying for more employees, more on CapEx, more acquisitions, repay debt, invest in other
assets, buy other companies, issue dividends or repurchase shares, spend on WC
Or, does the company need more funding because it has a cash flow shortfall?
Used in a DCF analysis (variation), LBO analysis, and standalone growth / financial statement
analysis, to determine a company's value, debt repayment capacity, what else it might do
with the excess cash it generates.
It's really important to dig in and see what's driving Free Cash Flow - organic revenue growth?
Expense cutting? CapEx or Working Capital changes?
BEST is when organic sales and economies of scale are driving growth - less good is when it's
inconsistent, or expense/CapEx cutting is driving it.

And even worse is when "games" and accounting gimmicks are affecting FCF and distorting the p
We'll see many examples of how to calculate and project this in the upcoming modules.

Amazon - FCF Excerpt from Financial Statements:

$
$

Year 3
23,257
(13,115)
10,142

Free Cash Flow Calculation:


Cash Flow from Operations:
Less: Capital Expenditures:
Free Cash Flow:

Year 3
(566)
(1,667)
531
103
(1,224)
(2,823)

Changes In Operating Assets and Liabilities:


Accounts Receivable:
Inventories:
Accounts Payable:
Accrued Liabilities:
Deferred Revenue:
Net Change in (Operating) Working Capital:

476,294
16,695

Annual Revenue:
Annual Net Income:

3,495 $
(979)
2,516 $

34,204
1,152

Year 1
3,903
(1,811)
2,092
Year 1
(866)
(1,777)
2,997
1,067
43
1,464
48,077
631

(0.6%)
(16.9%)

Net Change as a % of Revenue:


Net Change as a % of Net Income:

3.0%
232.0%

(20.1%)
56.4%
2.8%

Free Cash Flow Growth Rate:


CapEx as a % of Cash Flow from Operations:
CapEx as a % of Revenue:

(16.9%)
46.4%
3.8%

Revenue Growth Rate:


Net Income Growth Rate:
Cash Flow from Operations Growth Rate:

40.6%
(45.2%)
11.7%

1.6%
(6.0%)
(9.1%)

ain Cash Flow from Ops

Interpretation: CapEx jumping around so much that it's hard to say anything s
Free Cash Flow here - huge ramp-up in spending in the past 2 years.

uge, unpredictable way.

Revenue is growing at a good clip, and that is genuinely contributing to FCF grow
Cash Flow from Operations is also increasing - but Amazon is clearly also investin
into future growth, and we don't know what the payoff of that will be.

ng significantly in

les growth alone


it was also due

Good investment / strategy / company? Depends on how useful you think that C
is perhaps?

Not really "playing games" with Working Capital, but it is interesting how much t
have changed over time - the Accounts Payable changes really stand out, but th
reduces cash flow for Amazon.

he company have

nvest in other

ancial statement
se it might do

revenue growth?

good is when it's

and distorting the picture.

g modules.

Salesforce - FCF Excerpt from Financial Statements:

$
$

Year 2
4,180 $
(3,785)
395 $

Year 3
5,475
(3,444)
2,031

Free Cash Flow Calculation:


Cash Flow from Operations:
Less: Capital Expenditures:
Free Cash Flow:

Year 2
(861) $
(999)
2,070
1,038
275
1,523

Year 3
(846)
(1,410)
1,888
736
399
767

Changes In Operating Assets and Liabilities:


Accounts Receivable:
Deferred Commissions:
Prepaid Expenses:
Accounts Payable:
Deferred Revenue:
Net Change in (Operating) Working Capital:

61,093 $
(39)

74,452
274

Annual Revenue:
Annual Net Income:

$
$

2.5%
(3905.1%)

1.0%
279.9%

Net Change as a % of Revenue:


Net Change as a % of Net Income:

(81.1%)
90.6%
6.2%

414.2%
62.9%
4.6%

Free Cash Flow Growth Rate:


CapEx as a % of Cash Flow from Operations:
CapEx as a % of Revenue:

27.1%
(106.2%)
7.1%

21.9%
(802.6%)
31.0%

459
(91)
368

1,657
70

Revenue Growth Rate:


Net Income Growth Rate:
Cash Flow from Operations Growth Rate:

ard to say anything substantial about

Interpretation: FCF is genuinely growing each year, but we d


number because CapEx as a % of revenue also fell quite a bit

ntributing to FCF growth because


s clearly also investing a huge amount
at will be.

Genuine revenue growth, and since it's flowing down to Cash F


isn't manipulating its numbers with Working Capital policies (at
companies may).

eful you think that CapEx spending

Interesting Points Here: Will it continue to spend a lot on ac


its FCF? Still quite a bit left after paying for CapEx each year.

eresting how much the items


ally stand out, but that actually

And what are its future CapEx plans? Seems to a bit all over t
the numbers here.

If CapEx as a % of revenue will stay low, it's possible the compa

or perhaps even issue dividends or repurchase shares in the fu

Statements:
Year 1
$
$

Year 2

Year 3

592 $
(152)
440 $

737 $
(176)
561 $

875
(299)
576

Year 1
(245) $
(167)
(8)
80
445
105

Year 2
(183) $
(233)
(10)
193
479
247

Year 3
(425)
(265)
105
(29)
612
(1)

2,267 $
(12)

3,050 $
(270)

4,071
(232)

4.6%
(907.5%)

8.1%
(91.4%)

(0.0%)
0.5%

19.5%
25.6%
6.7%

27.6%
23.8%
5.8%

2.7%
34.2%
7.3%

36.8%
(116.6%)
28.8%

34.6%
2237.1%
24.6%

33.5%
(14.2%)
18.8%

each year, but we don't really buy into the Year 2


also fell quite a bit and then rose in Year 3.

wing down to Cash Flow from Operations, the company


ng Capital policies (at least, not to the extent that other

to spend a lot on acquisitions and other activities with


r CapEx each year.

ems to a bit all over the place right now, which is impacting

's possible the company will continue to spend a lot on acquisitions,

hase shares in the future.