- Capital Allocation Efficiency
Issue: FCF does not show how well you allocate your capital Solution: Calculate return on capital invested (ROIC) or return on equity (ROE)
Solution: Calculate return on capital invested (ROIC) or return on equity (ROE)
2. Growth vs. Maintenance Capex
issue: FCF does not differentiate Capital expenditure from operational cost
Solution: Separate growth expenses and maintenance expenses
3. Working Capital Fluctuations
Issue: FCF doesn’t capture short-term working capital needs.
Solution: Examine changes in receivables, payables, and inventory to assess how working capital impacts cash flow. Monitor trends
4.Non-Recurring Items
Issue: Free Cash Flow (FCF) encompasses both regular and irregular items, which can distort the actual cash generated from operations.
Solution: Standardize free cash flow (FCF) by excluding non-recurring items and adjusting for one-time inflows or outflows. This provides a more accurate representation of FCF derived from continuous operations.
5.Debt Structure and Interest Obligations
Issue: Free Cash Flow doesn’t account for the risks tied to your debt arrangement or the schedule of interest payments, which might affect your future liquidity.
Solution: Examine the ability to manage debt in depth, focusing on the schedule of debt repayments and interest obligations. This analysis assists in assessing liquidity and financial risk.
Free Cash Flow is an important measure, yet it doesn’t provide a full picture when considered alone. To gain a comprehensive understanding of financial health and growth potential, it’s crucial to examine the underlying elements of FCF, profitability trends, and capital efficiency.
