What is simple FCF in the example?
Reveal the worked answer
90 million.
130−40; persistence and valuation definition remain separate questions.
Fundamentals · FUND-04 · Core
Cash flow
Are reported profits becoming usable cash?
What you will learn and prerequisites
- Explain the mechanism in the lesson question.
- Reproduce the worked comparison and recognize its failure case.
Read first: Understand the business
Earnings recognize economic activity under accounting rules; cash flow records cash movement. Neither substitutes for the other. A profitable business can tie up cash in working capital, while a weakening business can temporarily release it.
Free cash flow requires a stated definition, not just an impressive label.
Understand the mechanism
Operating cash flow minus capex is a common shorthand. It can still contain working-capital timing and stock-compensation addbacks. It is not automatically the unlevered cash flow used in an enterprise DCF.
Stock compensation is an economic cost through dilution even when added back to operating cash. Model its effect consistently and avoid double-counting both a full cash-equivalent subtraction and the same dilution.
Walk through the process
Reconcile earnings to cash over several periods. Inspect inventory, receivables, payables, unusual receipts and capitalized spending. Distinguish maintenance and growth spending where evidence allows.
Align the cash-flow definition with the valuation claims and discount rate.
Evidence and decision boundary
These are original fictional teaching figures, not a company screen. Actual analysis should use primary disclosures and distinguish management's explanation from your inference. Favorable or unfavorable evidence depends on the specific business, valuation and risk; no single ratio establishes a recommendation.
A worked example
Harbor has operating cash flow 130 and capex 40, producing simple FCF 90 million. If 25 of OCF came from a one-time inventory reduction, recurring capacity may be lower.
Suppose OCF also adds back 30 of stock compensation. That does not establish one universal adjusted-FCF number; it requires a consistent treatment of the economic dilution cost. The chart separates OCF, capex and the unadjusted shorthand FCF.
Open the calculation without leaving this lesson
Cash flow—worked comparison
Vertical: USD millions
Horizontal: Operating cash / capex / simple FCF
1. Fictional example
Read the graph as a data table
| Operating cash / capex / simple FCF | Fictional example |
|---|---|
| 1 | 130 |
| 2 | 40 |
| 3 | 90 |
What would invalidate the reading?
Treating a temporary working-capital release as perpetual cash generation exaggerates value. Stretching suppliers is not equivalent to stronger customer demand.
Check your understanding
Try the question before revealing its answer. These are reading checks, not trading certification or a site completion record.
What is the critical failure to avoid?
Reveal the worked answer
Treating a temporary working-capital release as perpetual cash generation exaggerates value. Stretching suppliers is not equivalent to stronger customer demand.
Explain this risk before treating the example as a decision rule. A correct calculation does not guarantee a favorable market outcome.
Return to the question: Are reported profits becoming usable cash? State the observed facts, the assumptions and the failure condition separately.
Sources, assumptions and downloadable script
External references support definitions and conventions. Worked scenarios and prose are original. No current quotes or dealer inventory are claimed.
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