Adjusted Free Cash Flow and Capital Expenditures of the S&P 100: What Is the Source of Growth in Adjusted Free Cash Flow?

Abstract

Noteworthy growth in free cash flow has been well reported over the past few years as company management, financial analysts, and investors increasingly focus on cash flow to validate reported earnings. Unfortunately, the calculation of free cash flow has limitations, just like earnings. For example, as capital expenditures decrease, free cash flow increases by the same amount, and vice versa. Thus, a temporary reduction in capital expenditures could cause reported free cash flow to increase in an unsustainable way.

This study examines growth in adjusted operating cash flow (operating cash flow adjusted for nonoperating and nonrecurring items), adjusted free cash flow (similarly adjusted), and capital expenditures for the non-financial firms of the S&P 100 for the years 2000 through 2003. The objective is to measure the extent to which growth observed in adjusted free cash flow is derived from operations or through reductions in capital expenditures. Our results indicate that reductions in capital expenditures have been an important contributing factor to the growth observed in adjusted free cash flow in recent years.