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Mauboussin, Callahan - Categorizing for Clarity - Cash Flow Statement Adjustments to Improve Insight (2021)


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The linked Consilient Observer article is an easily accessible case study on making a few minor adjustments to the Cash Flow Statement that will appeal to Value Investors.

The authors provide not only helpful historical context around the accepted accounting, but also background on the perspective of the investor seeking to understand free cash flow.




The definition of free cash flow that investors and companies commonly use is cash from operating activities minus capital expenditures. This is inconsistent with finance theory and can be a very misleading heuristic.




They recommend 4 adjustments to the Cash Flow Statement, described in the attached table.




I personally found the article, and its presentation, to be very helpful!  I never liked the simple heuristic of just subtracting PP&E from NOPAT. Herein are some tools for capitalizing R&D and intangibles for a better estimate of the needed reinvestments!  

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Interesting article. It resonates with some of the ideas that Prof Damodaran preaches. He has got a few more up his sleeve such as treatment of long term leases on property and treatment of R&D as a capex and the adjustments necessary to do so.


Recognition of these ideas would have been very useful in valuation during early years of Amazon as its value was hidden behind the apparent close to zero net income.

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Yes, I'm also a fan of Damodaran's treatment of the subject. 🙂 

Just in case readers are not aware, Damodaran used to recommend proactively adding leases to liabilities because they weren't typically present on the balance sheet.  However, since 2019 operating leases are on the balance sheet (along w/ a corresponding asset for right-of-use). See ASC 842.

I presume Damodaran has changed his treatment of leases somewhat since that time. 


And yes the idea of applying these adjustments to historical statements is interesting since we have the benefit of hindsight.

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