Breaking Into Wall Street - The 3 Financial Statements

($ in Thousands)

Tax Rate: 40.0%

Income Statement: Balance Sheet:

Revenue: $ 700 Assets:

Cost of Goods Sold (COGS): 70 Current Assets:
Gross Profit: 630 Cash:
Gross Margin %: 90.0% Short-Term Investments:
Accounts Receivable:
Operating Expenses: Inventory:
Sales & Marketing: 165 Prepaid Expenses:
Research & Development: 75 Total Current Assets:
General & Administrative: 50
Total Operating Expenses: 290 Long-Term Assets:
Property, Plant & Equipment:
Depreciation: 10 Goodwill:
Amortization of Intangible Assets: 10 Other Intangible Assets:
Stock-Based Compensation: 20 Long-Term Investments:
Total Long-Term Assets:
Operating Income (EBIT): 300
Operating Margin: 42.9% Total Assets:

Other Income / (Expenses): 20 Liabilities & Equity:

Interest Income / (Expense): (20) Current Liabilities:
Goodwill Impairment: (50) Revolver (Short-Term Debt):
PP&E Write-Down: (10) Accounts Payable:
Gains / (Losses) on Investment Sales: (15) Accrued Expenses:
Deferred Revenue:
Pre-Tax Income (EBT): 225 Total Current Liabilities:

Income Taxes: 90 Long-Term Liabilities:

Current Portion: 40 Debt:
Deferred Portion: 50 Deferred Tax Liability:
Total Long-Term Liabilities:
Net Income (Profit After Taxes): $ 135
Net Income Margin: 19.3% 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?
 Cash Flow Statement:
Start of End of
Period Period Cash Flow from Operating Activitie
nt Assets: Net Income:
$ 300 $ 660 Depreciation:
ort-Term Investments: - - Amortization of Intangible Assets:
counts Receivable: - 50 Stock-Based Compensation:
- 30 Goodwill Impairment:
paid Expenses: - 30 PP&E Write-Down:
Current Assets: 300 770 Deferred Income Taxes:
(Gains) / Losses on Investment Sales
Term Assets: Change in Operating Assets & Liab
perty, Plant & Equipment: - 30 Change in Accounts Receivable:
100 50 Change in Inventory:
her Intangible Assets: 50 40 Change in Prepaid Expenses:
ng-Term Investments: - 100 Change in Accounts Payable:
Long-Term Assets: 150 220 Change in Accrued Expenses:
Change in Deferred Revenue:
$ 450 $ 990 Cash Flow from Operations:

s & Equity: Cash Flow from Investing Activities

nt Liabilities: Capital Expenditures (CapEx):
volver (Short-Term Debt): $ - $ 50 Purchases of Short-Term Investment
counts Payable: - 15 Purchases of Long-Term Investments
crued Expenses: - 10 Proceeds from ST Investment Sales:
ferred Revenue: - 15 Cash Flow from Investing:
Current Liabilities: - 90
Cash Flow from Financing Activities
Term Liabilities: Debt Raised:
- 240 Debt Principal Repayment:
ferred Tax Liability: - 50 Revolver Issued / (Repaid):
Long-Term Liabilities: - 290 Equity Issuance:
Dividends Issued:
Share Repurchases:
mmon Stock & Additional Paid-In Capital: 50 170 Cash Flow from Financing:
ained Earnings: 400 485
asury Stock: - (50) FX Rate Effects:
cumulated Other Comprehensive Income: - 5
$ 450 $ 610 Net Change in Cash:

Liabilities & Equity: $ 450 $ 990 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:

$ 135
reciation: 10
ortization of Intangible Assets: 10
ck-Based Compensation: 20
dwill Impairment: 50
E Write-Down: 10
erred Income Taxes: 50
ns) / Losses on Investment Sales: 15
e in Operating Assets & Liabilities:
nge in Accounts Receivable: (50)
nge in Inventory: (30)
nge in Prepaid Expenses: (30)
nge in Accounts Payable: 15
nge in Accrued Expenses: 10
nge in Deferred Revenue: 15
Cash Flow from Operations: $ 230

low from Investing Activities:

ital Expenditures (CapEx): $ (50)
chases of Short-Term Investments: (100)
chases of Long-Term Investments: (100)
ceeds from ST Investment Sales: 85
Cash Flow from Investing: $ (165)

low from Financing Activities:

$ 300
t Principal Repayment: (60)
olver Issued / (Repaid): 50
ity Issuance: 100
dends Issued: (50)
re Repurchases: (50)
Cash Flow from Financing: $ 290

e Effects: 5

ange in Cash: $ 360

ning Cash Balance: $ 300

g Cash Balance: $ 660

ash Flow: $ 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: Year 1 Year 2

Cash Flow from Operations: $ 23,643 $ 24,255 $ 25,591
Less: Capital Expenditures: (12,699) (13,510) (12,898)
Free Cash Flow: $ 10,944 $ 10,745 $ 12,693

Changes In Certain Assets and Liabilities: Year 1 Year 2

Accounts Receivable: $ (796) $ (614)
Inventories: (3,727) (2,759)
Accounts Payable: 2,687 1,061
Accrued Liabilities: (935) 271
Accrued Taxes: 994 981
Net Change in (Operating) Working Capital: (1,777) (1,060)

Annual Revenue: $ 421,395 $ 446,509 $ 468,651

Annual Net Income: 16,993 16,387 17,756

Net Change in WC % Change in Revenue: (7.1%) (4.8%)

Free Cash Flow Growth Rate: (1.8%) 18.1%

CapEx as a % of Cash Flow from Operations: 55.7% 50.4%
CapEx as a % of Revenue: 3.0% 2.8%

Revenue Growth Rate: 6.0% 5.0%

Cash Flow from Operations Growth Rate: 2.6% 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 Free Cash Flow Calculation: Year 1

$ 23,257 Cash Flow from Operations: $ 3,495 $ 3,903
(13,115) Less: Capital Expenditures: (979) (1,811)
$ 10,142 Free Cash Flow: $ 2,516 $ 2,092

Year 3 Changes In Operating Assets and Liabilities: Year 1

$ (566) Accounts Receivable: $ (866)
(1,667) Inventories: (1,777)
531 Accounts Payable: 2,997
103 Accrued Liabilities: 1,067
(1,224) Deferred Revenue: 43
(2,823) Net Change in (Operating) Working Capital: 1,464

$ 476,294 Annual Revenue: $ 34,204 $ 48,077

16,695 Annual Net Income: 1,152 631

(36.9%) Net Change in WC % Change in Revenue: 10.6%

(20.1%) Free Cash Flow Growth Rate: (16.9%)

56.4% CapEx as a % of Cash Flow from Operations: 46.4%
2.8% CapEx as a % of Revenue: 3.8%

1.6% Revenue Growth Rate: 40.6%

(9.1%) Cash Flow from Operations Growth Rate: 11.7%

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
ng significantly in into future growth, and we don't know what the payoff of that will be.

Good investment / strategy / company? Depends on how useful you think that C
les growth alone is perhaps?
it was also due
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 Year 3 Free Cash Flow Calculation:

$ 4,180 $ 5,475 Cash Flow from Operations: $ 459
(3,785) (3,444) Less: Capital Expenditures: (91)
$ 395 $ 2,031 Free Cash Flow: $ 368

Year 2 Year 3 Changes In Operating Assets and Liabilities:

$ (861) $ (846) Accounts Receivable:
(999) (1,410) Deferred Commissions:
2,070 1,888 Prepaid Expenses:
1,038 736 Accounts Payable:
275 399 Deferred Revenue:
1,523 767 Net Change in (Operating) Working Capital:

$ 61,093 $ 74,452 Annual Revenue: $ 1,657

(39) 274 Annual Net Income: 70

11.7% 5.7% Net Change in WC % Change in Revenue:

(81.1%) 414.2% Free Cash Flow Growth Rate:

90.6% 62.9% CapEx as a % of Cash Flow from Operations:
6.2% 4.6% CapEx as a % of Revenue:

27.1% 21.9% Revenue Growth Rate:

7.1% 31.0% 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 Genuine revenue growth, and since it's flowing down to Cash F
s clearly also investing a huge amount isn't manipulating its numbers with Working Capital policies (at
at will be. 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 And what are its future CapEx plans? Seems to a bit all over t
ally stand out, but that actually 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 $ 737 $ 875
(152) (176) (299)
$ 440 $ 561 $ 576

Year 1 Year 2 Year 3

$ (245) $ (183) $ (425)
(167) (233) (265)
(8) (10) 105
80 193 (29)
445 479 612
105 247 (1)

$ 2,267 $ 3,050 $ 4,071

(12) (270) (232)

17.2% 31.5% (0.1%)

19.5% 27.6% 2.7%

25.6% 23.8% 34.2%
6.7% 5.8% 7.3%

36.8% 34.6% 33.5%

28.8% 24.6% 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.