Question

Analysts calculated that Starbucks total free cash flow for the months ended in June 2017 was $763 million. Its net income for the months ended in June 2017 was $692 million. From class, what is the definition of free cash flow? If you are considering an investment in SBUX, should you be more interested in free cash flow or net income?

Answer 1

Free cash flow refers to the cash generated by a business after conducting its operations and after reducing capital expenditure. The cash that remains after paying for operating expenses and keeping money aside for capital investments is called free cash flow. This excludes changes in working capital and does not consider interest expense since it only looks at operating cash flows.

While considering an investment in SBUX, we should be more interested in free cash flows rather than net income. Stock is valued based upon the FCF rather than Net Income. This is because net income is accounting income and considers non cash expenses like depreciation. It also depends upon accounting policies of the firm. The FCF on the other hand gives an estimate of the core wealth generated and is a determinant of the intrinsic earning capacity of the firm.