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Changes in operating assets and liabilities:

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I have looked at many a cash flow statement , more generally to determine free cash flow generation.

I am often stymied by the "Changes in operating assets and liabilities:" line that appears within operating cash-flows. Can these safely be ignored?

For example, I just use the net income, backout any charges other than these operating asset/liability movements and deduct certain capital expenditures...

Few comments about working capital and the impact on CFO.

-There is an inherent bias to improve the cash flow position and so to "take advantage" of working capital end of period adjustments but I think that these adjustments are likely minor in most cases and are inconsequential in the long term.
-In a typical business (more complicated if many different subs), the ratio of working capital to assets should remain relatively constant. What I look for is a tendency for small but incremental decrease in this ratio or a rapid regression to the mean after an acquisition or major expansion. An argument could be made that relentless improvements in accounts receivables and inventory mangement can contribute to the free cash flow number over time. Not many firms can achieve this.
-Otherwise, unless there are liquidity/distress issues, I just remove the non-cash working capital adjustment in order to estimate free cash flow. I have also used a three year rolling average.

The challenge is more with "certain capital expenditures". Disclosure, even in the MD&A, does not usually, allow a precise estimation of free cash flow after "maintenance" capex. Dissection of the depreciation expense vs fixed assets vs capex over time can be helpful. I find that firms that report free cash flow measures tend to be optimistic. 

That's very interesting. It sounds like there are various flavours of capex, depreciation and amortization. Some are more desirable than others. Just wondering what some differences would be. Amortization I remember Buffett saying was more likely not to be a real expense but in fact the asset could be worth more than purchase price , much less a depreciated sum. An example  - some countries allow depreciation of domain names. I guess maintenance capex is less desirable than growth capex, unless the capex results in no growth!

Evaluating the amortization of defined-life intangibles can be tricky. It can go both ways.

Going to the initial transaction that gave rise to the intangible recognition and following up on profitability can help but acquired operations are often melted into something else. It may take a while before trends appear.

I don't see aggressive amortization of intangible value as a serious problem because the earning power should eventually be recognized in retained earnings. I much prefer too rapid amortization to the sudden realization that a massive write-down is necessary. A point can be made that well established pattern of excessive amortization could result in an upward adjustment to the free cash flow estimate.

There is one non-cash cash flow item that I often stumble upon: the amortization of share-base expense and its tax implication. It is clear that the item does not affect present free cah flow but it clearly affects the free cash flow per share down the line. Many ways to deal with this. Instead of trying to estimate eventual share dilution, I tend not to add it back. This "looks like a free lunch" item can be particularly costly over time if the hard earned cash of the firm is used after to buy back overvalued shares.

If I add back the share based compensation, I will use the fully diluted share count including RSUs and stock options. If I don't add back the compensation, I will use the share count without these items.


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