its feels nyc to tell you that clearing CFA level 1 does let to the call for an interview to the position of Research analyst at a broking firm. I am already done with two interviews, in first one he explained me about the work and told me to make a valuation report on a sample company . The company which he gave me had a negative CFO and positive Net Income. I “tried to do a DCF analysis” which led to the company price should be at 107 Rs rather than its current market price of 77 Rs. He grilled me in the interview by asking that how can there be free cash flow in the company as there negative CFO and also the company is investing in Capex which is even taking it towards more negative.
The formulae of Unlevered Free cash flow i am using is EBIAT plus D&A less Capex Less Inc in WC.
He has called me for another interview which is next week to check the mistakes and come back with the report, I still dnt know how the impact of negative CFO how will it affect the FCF and also the calculation of implied equity share price.
Remember that the Firm may have a positive FCF and with negative CFO because CFO takes into account the interests over the company’s debt. Perhaps this company is in a ramp up phase which requires a lot of initial capex which can be financed in part by debt. My advice is to consider the company’s projects and financial leverage and other approches to valuation as well (rather then the DCFF approach you can use DCFE approach or comps). Hope I could be helpful.
NEVERGIVE UP!!! I would exercise caution in sharing the name of the company you’re interviewing with.
Let’s see:
Off the top of my head:
CFO:
Net income + dep - Swap interest +changes in WC (AR, DT, Payables…) + Noncash charges…
Essentially think of CFO as any cash receipts - operating expense - interest - taxes (already included in Net income in the above cal) but not in the direct method.
If the company has negative CFO it could be that AR has increases and they have paid payables (wages, interest…etc). Sounds like an early stage company with more expenses than revenue.
Investing cash flows would be lower is the company is investing in capex (that’s OK). Lower means… a bigger negative number.
Look at cash flows from financing ( did they issues massive debt? This would be a cash inflow. Was there a capital contribution from investors, equity inflows!
When getting to unlevered free cash flow. Look at adjusted EBITDA!!! This should take into account a crap load of adjustment like executive salaries, any gain/losses on infrequent items, legal fees… if you adjust EBITDA, you’ll start with a higher EBITDA value.
Adj EBITDA
less: Dep
= EBIT
less taxes
NOPAT
plus Dep - WC - CAPEX
= Unlevered Cash flows!!! maybe after certain adjustment this number would be bigger
By the way… a company can have negative cash flow in the earlier years as it ramps up its business. I think the key is in adjusting EBITDA!!!
I apprecate your consideration to answer the question. the company I am studying is not a new company It has been in the business from the past 40 years. I know negative CFO and CFI and Positive CFF does gives the impression of the new company in its growth stage… But this is not the case with this company. Can this mean the company is in the end stage of it life cycle…?
an older company - with declining sales would show symptoms of negative CFO.
Negative Cash Flows from Financing Activities could mean that the company is taking on more long-term debt or issuing more equity, but it could also mean that the company is making higher dividend payments or more stock repurchases.
by that token - Positive CFF = paying off Long Term Debt, retiring Equity, lower dividend payments, lower stock repurchases. Lower Dividend payments - would show up in a lower DCF valuation.
When company pays off debt - and since FCFE takes off the amount of Debt paid - this would show up as a -(-) operation and show a positive FCFE valuation.
Company investing in CAPEX = CFI.
Not sure if I am really answering the question here, though.
Hello, positive net income with negative cash flow from operations might be the result of including gains which are non recurring. As we all know the net income is filled with mgt discretions, estimates and assumptions. So might be there are chances that net income was inclusive of the gains which are non recurring and resulted in cash flow from operations which was negative
Also, the interviewer was right in pointing out that negative cash flow from operations cannot result in positive free cash flow to the firm. So the valuation method which can be used here to value the company’s equity could be residual income method