Is Free Cash Flow Free?

mmmmm, yeah, ok. Definitely a good discussion and it is definitely great to see venerable names return to the board.

So continuing this technical GAAP/non-GAAP/tangible/intangible/comprehensible/incomprehensible discussion:

I am long out of business accounting and the rust overtook the chrome some time ago, so let’s simplify.

Starting with cash accounting:
Income minus Expenses; what’s left I am free to reinvest, take home or pay to shareholders.

Accrual accounting:
Everything else.

If I don’t pay my bills (sure, I’m within terms, but my payables are increasing), I have free cash flow. If I borrow money or sell stock; free cash flow, etc, etc & etc.
I see these SaaS companies yammer on about free cash flow, but what is the source of that cash? It’s great that they are generating it and reinvesting it, but they then have to stay ahead of the wolf, no?



Hi Randy,

There’s a style of investing that says accounting details don’t matter as long as a
company is making progress towards profitability and positive free cash flow. That’s
how Enron was able to fool a significant mumber of investors in 2001. Many of them
lost their life savings by ignoring the nitty gritty.

Details do matter. That’s why I’m happy to see you spark these discussions.

You’re right, companies do yammer on these days about free cash flow. That’s because
after Enron and other perps, investors perceived that cash flow was somehow more immune
to fraud than earnings. Management has picked up on that focus. The risk is they turn
to “creative” ways of giving investors what they’re looking for in cash flow reporting.
Even more reason why details matter.

Free Cash flow is not a GAAP measure. So it’s open to however management wants to define
it. And different management teams will define it in different ways. One reason for this
is that the free cash flow measure has many uses in the modern corporation – as a metric
in loan covenants, in incentive compensation plans, and in impairment analysis to name
a few. But more importantly, it’s widely used in valuation which means management will
want to define it in a way that makes them look good.

We can define it in a way that’s useful to us. We can start by asking what we mean by
free cash flow. In this case, “free” can mean “no strings attached”. In other words,
deploying it does not affect the firm’s ability to generate more.

Best to you,


but what is the source of that cash?

Should be revenues. If it is not e.g. cash from capital raise, then it is not being determined well.

but they then have to stay ahead of the wolf

well, yeah. Cash is free, when it is free of current obligations. But a quarterly or annual cash flow statement is still a snapshot. Whether it is sustainable is an entirely different question and requires some insight into the business and landscape.