Different Definitions Of Free Cash Flows In Practice

With the ongoing reform of non-tradable shares, the ratio of non-tradable shares in listed companies has been decreased. Therefore, the model of measuring the value of an enterprise becomes more important than ever. But one of the most popular models in overseas market, the discounted free cash flow model by using absolute value approach, has not been put into good practice. Based on previous survey and research, this paper summarized relative previous literature, compared the difference among evaluating methods, and analyzed the problems in suing free cash flow method. After collecting six calculating approach, this paper finally got the best fit via empirical analysis. FCF3 (cash flows from operating activities minus net capital expenditure) and FCF4 (cash flows from operating activities minus cash flows from investing activities) has the best fit for the listed manufacturing companies in China’s stock market.In the theoretical part, the paper talked about the different metrics in calculating free cash flows, as well as the disclosure of it, from the perspective of investors. Also it pointed out the disadvantage of using the free cash flow models. Specifically, by comparing the difference among free cash flow model, discounted EBITDA model, discounted cash earnings, multiples and DDM model, it discovered that the advantage of free cash flow relatively is taking the change of working capital and capital expenditure into consideration, at the same time, it considered to be more accurate than the most used method, the multiples. In addition, this paper illustrated an important obstacle when using free cash flow model in practice — lacking universal rules, which potentially lead to problems in disclosure and valuation. And those are the inducement of valuation risk and agency problems.In the empirical analysis, this paper was trying to discover the best free cash flow calculating method by using different calculating approaches to estimate 49 manufacturing companies’value, and then comparing these values to real ones. It turns out that FCF3 and FCF4 is considered relatively better to reflect the real stock price. The results may imply some problems in today’s market, which may include the immaturity of the capital market, the lagging of valuation systems and the poor situation of stock market supervision.