A commonly heard term is CASH FLOW. Here is what I know: ask the person using the term to define what they mean by describing the formula they are using. There are at least 9 variations on the theme of cash flow. Let’s look at the tree to appreciate what seem to be the most common uses.
Gross Cash Flow: Net Operating Profit Less Adjusted Taxes (NOPLAT) + depreciation.
This number is a “snapshot” in time. Investors and business owners like this number because it speaks to dividends.
Free Cash Flows: this number is dynamic in nature in that it includes shifts over time. It describes cash not required for operations or for reinvestment. In terms of the tree its formula would be:
Free cash flows=
EBIT (earnings before interest and taxes also called Operating Earnings)
– Taxes (not addressed on the Tree)
+ Book Depreciation
– Changes in Plant, Property and equipment (CAPX, Capital expenditures)
– Changes in Working Capital (ChgWC)
Pay close attention that we are subtracting changes which have occurred in our Invested Capital. Watch your signs! If we have reduced inventory and reduced PPE from the previous measurement period our free cash flow will show an increase. If we have increased our Invested Capital, free cash flow will show a decrease from the previous period. Therefore, a good metric for a soundly implemented Kaizen would be a strengthening free cash flow number.
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