Chapter 5 of 8
Cash flow and free cash flow: follow what remains
Bridge profit to operating cash and distinguish maintenance investment, expansion and financing.
In this chapter
Begin with the reported cash-flow statement #
Operating cash reflects cash linked to operating activity under the accounting presentation. Noncash items and working-capital changes explain why it differs from accounting profit. Read classification policies for interest, tax and other items.
Investing cash includes capital spending and other investing activity; financing records items such as borrowings and capital transactions. A positive net cash change can come from financing rather than a healthy operating engine.
Read depreciation and capex together #
Depreciation is an accounting allocation; capex is spending on assets. Adding back depreciation in a cash bridge does not make asset replacement unnecessary.
Maintenance and growth capex can be difficult to separate from public disclosures. State the estimate and uncertainty. A firm postponing investment may show strong short-run cash flow while weakening its future capacity.
Keep the claim and discount rate consistent #
A common FCFF definition is EBIT×(1−tax rate)+depreciation−capex−increase in operating working capital. It is an unlevered operating cash measure for all capital providers, with assumptions stated.
A common FCFE bridge is net income+depreciation−capex−working-capital increase+net borrowing. Interest already included in net income must not be subtracted twice. Alternative starting points require explicit adjustments; the labels alone do not ensure consistency.
Test funding across the whole path #
One year of positive free cash flow does not prove that a multi-year expansion is funded. Build opening cash, operating generation, capex, debt maturities and distributions period by period.
Cash restricted for a purpose may not be available for shareholders. Check covenants and use-of-funds restrictions where disclosed, without turning this into a legal-rule lesson. The research question is economic availability and survivability.
Hypothetical worked example
A fictional FCFF calculation
EBIT ₹20 crore, illustrative cash tax assumption 25%, depreciation ₹4 crore, capex ₹10 crore and working-capital increase ₹3 crore give FCFF = 20×0.75+4−10−3 = ₹6 crore.
The 25% is a fictional model assumption, not current tax advice. Do not deduct interest from this unlevered measure and then discount it at an all-capital rate as if the cash definition had not changed.
Common mistakes
- Subtracting interest twice in an equity cash-flow bridge.
- Assuming depreciation add-back removes replacement spending.
- Counting restricted cash as freely distributable.
Under the stated FCFF definition, where does interest belong?
Make this chapter useful
Can you defend the reasoning?
Before moving on, answer the self-check in your own words and write why each alternative fails. Use the worked example to test that explanation. Then apply it in the module research task; keep the assumptions and the evidence that could change your answer.
Desk assignment
What to submit
Produce reconciled CFO, FCFF and FCFE schedules with stated classifications, financing movements and maintenance-capex uncertainty.
Use the research ledger for dated evidence, or the module workbooks for calculations. Separate observations, assumptions and interpretation.
Sources and further reading
- NISM: Research Analyst learning topics (scope reference; independent lessons) ↗
- NSE: company integrated financial filings ↗
Further-reading references from the curriculum source list. Contract sizes, expiry calendars, settlement references, margin parameters and tax treatment can change; verify the current operative documents for the actual product. Worked figures are illustrative, not current quotes.
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General financial education. No securities recommendation, assured outcome or personal advice. Read the risk disclosures.