The process of calculating free cash flow is relatively straightforward. Most define it as the following (assuming the direct method);
+ Non cash charges (depreciation/amortization)
+/- Changes in working capital
- Capital expenditures (some prefer to use maintenance cap exp)
= Free Cash Flow.
Although it is a simplified formula, this definition works well in most cases. We should always attempt to dig deeper into these numbers where appropriate. In my experience of analyzing company’s cash flows, there is a type of company where I feel this formula falls short. It’s with the serial acquirer. I’m not talking about those large deals that grab the headlines such as Intel, HP, or IBM. I’m talking about companies that consistently make small acquisitions annually as part of their business plan. They usually occur when a good size company dominates a niche market that is highly fragmented. With this in mind, let’s begin with our first example;
VCA Antech (WOOF)
Period End Date
Stmt Source Date
Stmt Update Type
Net Income/Starting Line
Changes in Working Capital
Cash from Operating Activities
Other Investing Cash Flow Items, Total
Cash from Investing Activities
There is nothing inherently wrong with making these ‘tuck-in’ acquisitions as long as they profitably contribute to the long term growth plan. However, they must be accounted for in the free cash flow calculation – at least in my opinion. These acquisitions represent an ongoing capital expenditure – similar to a retailer spending cap exp to expand its footprint. The company’s acquisition history is clearly laid out in the 10K filing. However, if you want to take the quick and dirty approach simply subtract out “other investing cash flow items” from the standard free cash number. While it isn’t perfect it will give you a much better (and more conservative) indicator of real cash being spent on the business.