Course 208: What Is Free Cash Flow?
What Free Cash Flow Tells You
In this course
1 Introduction
2 What Free Cash Flow Tells You
3 Big Spending and Cash Flow Can Work Together
4 When Spending Doesn't Generate Cash Flow
5 Using Free Cash Flow

To see what free cash flow tells us that earnings don't, take a look at Rainforest Cafe RAIN, the operator of theme restaurants (its stock has taken a nosedive since the end of 1997). From 1995 through 1997, the company posted $100,000, $5.9 million, and $12.3 million in earnings. Nice growth, right? The company's free cash flow, by contrast, was negative $7.0 million, negative $28.0 million, and negative $57.4 million. Free cash flows also grew--but in the opposite direction as earnings. That's not necessarily bad. Free cash flow is equal to the cash a company generates minus the amount it invests. Rainforest Cafe is investing a lot, which is why its free cash flows are negative. How much is a lot? A quick way to tell how quickly a company tears through money is to compare its capital spending with its long-term assets (mostly, its plant and equipment). While not always perfect, the comparison at least gives us an idea of how aggressively a company is spending. Rainforest Cafe's capital spending as a percentage of its current assets has been as high as 43%. That's one prolific spender. At the opposite end of the spectrum would be a company like Philip Morris MO, which cruises along spending an amount equal to about 5% of its long-term assets. When you see a percentage as high as 30% or 40%, chances are you're dealing with a young company just getting on its feet.

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