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Free cash flow

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viciam

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Hi all,

I'm hoping someone will be kind enough to share their knowledge with me.

I'm looking at the free cash flow ratio, what exactly is 1-Tax Rate in the formula? I've no idea what it's referring to

[Earnings Before Interest Tax * (1 – Tax Rate) + Depreciation + Amortization – Change in Net Working Capital – Capital Expenditures]


Thanks in advance
 

I've never studied finance but I if you think about what free cash flow is you should be able to work out what the formula is doing. If you are trying to work out how much cash is available to the business at the end of the period then you have to make provision for tax (because the tax man only accepts hard cold cash). So, with the company tax rate at 30%, you need to multiply EBIT by (1-0.3) which is EBIT * 0.7 to work out what the earnings will be after tax. The assumption this formula is making is that there are no losses from previous periods to offset.
 
Oh I see.

But where exactly does the 1 come from? What's the reason or story behind it?
 
viciam said:
Oh I see.

But where exactly does the 1 come from? What's the reason or story behind it?
Click to expand...

The 1 is 100% (of your pre-tax profit)

For example:
If you have a tax rate of, say, 30%, then you have to multiply your pre-tax (iow your taxable) profit by the complement (i.e. 100% minus that rate) in order to get the remainder.
You take 100% profit - 30% tax, leaving 70%, which, in decimal notation, is (1 - 0.3).

I hope that explains it.
 
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