No. of Recommendations: 3
For example i'm using TTM numbers for The Trade Desk (TTD) and change in working capital es -59,950. If i substract this, it turns into a positive. Is this correct or should I treat cashflow numbers as absolute and use the formula's signs (+/-)?

You can have positive and negative changes in working capital, so don't change the sign. Subtract the negative number and you'll get an increase in owner earnings. That's totally fine. Think of it this way: let's say you collected on a bunch of receivables so your current assets went down. That's a good thing. Or maybe your inventory shrank a whole bunch after the Christmas selling season. Or maybe your accounts payable went up because you were able to extend your payment terms. Working capital is just current assets minus current liabilities, so if all other things stayed equal, you'd have a negative change in working capital if a component of current assets went down or a component of current liabilities went up. Either one of these happening means less money is required to be tied up in the business (at least there was this quarter/year).

The second doubt i had arose while looking at some examples and articles, since some did include things like: stock based compensation, deferred taxes, other working capital but these were not in the original definition of the formula.

Yes, that's because "owner earnings" or free cash flow is not a GAAP term. Since it's not specifically defined in GAAP, there are multiple flavors of it. Personally I add back in stock-based compensation since it is a non-cash charge, but then I also use the fully-diluted share count when I do my valuation to get a per share value. Share based compensation is definitely an expense so you want to factor it in somehow. You won't find any single, concrete definition of what free cash flow is.

Another thing I should point out is that the strength of the cash flow statement is it shows you the actual cash going into and out of the business for one particular period, but that's also the cash flow statement's weakness. If a large, one-time event occurs in that period, you'll see it in the cash flow statement but it will likely be smoothed over in the income statement. If it's a one-time or occasional thing (like a large acquisition, or a large fine, or a large build up of inventory right before the holiday season) and you factor it into owner earnings like it will always be there, you'll be misrepresenting owner earnings/free cash flow. What I like to do is look at a period of the last five years and see what owner earnings have done over a span of time, to make sure I'm getting a representative view of the company. When I do my valuation I usually go with a free cash flow estimate that's somewhere in between the completely smoothed-over income statement and the very bumpy cash flow statement

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.