Originally posted by datta.supratik Basantji,What do you exactly mean by free cash flow? How do we calculate that from balance sheet. Is it cash and cash equivalents end of the year? And I hope that a part of this will be distributed right?~Supratik

Free cash flow could be calculated as:

EBIT*(1-t) + Depreciation - Change in Working Capital - Capex

you should be able to find EBIT, t (tax rate), depreciation in the income statement

working capital is defined as current assets - current liabilities, both of which could be found in balance sheet. since, we are interested in change in working capital, you will have to take the data for both the years, current year and the previous year.

capex could be taken from the balance sheet or from investing cash flows.

Please note this will give you free cash flow to the firm, which when discounted at WACC will give you Enterprise Value. This is related to Equity value as:

Enterprise value = Equity value + Net debt (which is essentially Debt - Cash)

To calculate free cash flow to equity, you will have to add new debt and subtract debt repayment from free cash flow to the firm. Free cash flow to equity when discounted at Re will give you Equity value.

Now, while a firm may show an increase in profits consistently, it is of a little value to its shareholders if the free cash flows are not going up or if there is no free cash at all or negative free cash flows (doesn't happen with good companies, but not uncommon with companies that go burst). But please note, free cash flows could be low/negative because of several reasons (various combinations of the components which are used for calculating free cash flows). So, one may try to fool the investors with P&L, but one cannot fool investors with free cash flows. EBITDA has similar characteristics, because it stays away from the effects of capital structure (% of debt and equity, thus different interest income and thus different profit) and depreciation & amortization (which at times could be arbitrary). That's one of the main reasons why PE investors (or those who think along the same lines) give so much of importance to DCF (discounted cash flows) or EBITDA.

Another thing: One of the main drawbacks of using tools such as RoCE and RoE is that they measure return against the book value of assets in the business, which when depreciated might continue to give high(er) RoCE/RoE even though cash flows could tell a different story. In the process, older businesses (something like Hawkins I assume) with depreciated assets are likely to have higher RoCE than newer, possibly better businesses. Cash flows are affected by inflation and take latest values into consideration, but the book value (of assets) does not, and hence cash flows provide a clearer picture about the company.

Edited by rkgautam - 24/Aug/2011 at 12:21pm

lets have an imaginary balance sheet

shareholders equity             2010       2011

Originally posted by bobdylan lets have an imaginary balance sheet shareholders equity             2010       2011 share capital                      100000      100000 reserves/surplus                   20000       25000   debt(long term)                    20000        25000 gross block                          150000      175000 accumulated depreciation     75000         78000   current assests                    100000       125000 (cash,inventory,debtors)   current liabilities                    70000          90000 (creditors,provisions etc) working capital                      30000         35000 c.asset-c.liability  capex(2011)=gross block(2011)-gross block(2010) =175000-150000=25000(assuming no sale of assets) change in working capial=35000-30000 =5000(u have spent extra cash in maintaining inventory,debtors etc) assuming  free cash flow from operations is 50000 free cash flow is 50000-capex(25000)-change in wc(5000) 20000(for year 2011) tried my best,seniors can correct/add on/

Ok, let me give it a shot. Looking at balance sheet of Mayur Uniquoters here ... http://www.moneycontrol.com/financials/mayuruniquoters/balance-sheet/MU

FCF = CFO - capex - change in WC
CFO Mar 11 = 17.24
Capex = 48.48 - 37.75 = 10.73
Working capital, am assuming is the same as Capital work in progress.
Then change in WC = 4.41-1.06 = 3.35

So now FCF = 17.24 - 10.73 - 3.35 = 3.16
Right?

Thanks ALL,

It is now clear. That was a lot of effort with elaborate explanations.
It has been really helpful for me.

Thanks a lot again. 
Love TEDies!!

~Supratik