I have already written about free cash flow (FCF) and discounted cash flow (DCF), the two most prominent terms used by accountants when talking about cash. But they have invented others.
There are, for instance, two other obscure FCFs. The first is a version of free cash flow called unlevered free cash flow, the second is a free cash flow that isn’t free.
Unlevered free cash flow (never known as UFCF) is a theoretical variation of FCF used to compare the valuation of different companies without taking into account their debt structure. Accountants have conjured up a process best described as ‘let us ignore an important part of the financial make up of a company, the debt and compare it to others also without the debt’. This will give us an insight into the ‘fundamental’ valuation of the company, they say. They dream for a while and then have to come back to reality by recognising that debt exists and so revalue the company with the debt. Note the theoretical, fundamental, nice-to-know evaluation that accountants dream up before coming back to the real world.
But there is a second, rather obscure FCF, though, luckily, accountants don’t call it by its initials. This is ‘Unlevered free cash flow, sometimes known as the ‘cash flow fade model’. I found this unintelligible definition on the Vernimmen.com website:
“The cash flow fade model is a valuation model based on DCF that takes into account the phenomenon of gradual convergence of ROCE to WACC after the end of the Explicit forecast period.” [1]
To understand fade cash flow accountants have to understand the well-known cash flow, DCF, as well as three rarely used accounting concepts, ROCE, WACC and the Explicit forecast period (with a capital E). I will not go into the explanations here, I just wonder how complicated this model is made for accountants by accountants, just so that it can never be used by non-accountants.
And then there is the relatively unknown ‘Reverse DCF’ which is supposed to enable us to calculate the assumptions of revenue growth rates that are hidden in the market valuation of the company. Now only a handful of accountants worldwide want to know what the market thinks of future growth rates. They would be better off simply asking the CFO of any particular company to get a more realistic version of potential growth. However, they must believe that what the market thinks is better for them. These accountants use the Reverse DCF Model to calculate what the market thinks.
But wait! There are so many variations of the reverse DCF model, so many assumptions in the model and so many assumptions needed to calculate future financial performance that we end up with a result useful solely for the accountant making the calculation.
Not content with merely an excessively complicated notion of cash flow, accountants have come up with excessively numerous different types of cash flow. They invent them for industries, for instance the broadcast cash flow for the broadcasting industry. They have continuous cash flows, uniform cash flows, synthetic cash flows, net cash flows and even fuzzy ones which they call, with admirable clarity, fuzzy cash flows. They never call this one FCF or it would become mixed up with the more well know free cash flow or the unknown fad cash flow.
And then I discovered, by chance, the CFO which turns out not to be the Chief Financial Officer. Oh no, this is that other CFO, the cash flow from operating activities. Now that was a surprise! History does not record why they didn’t call it ‘CFOA’ to differentiate it from our well known senior financial manager? And what, I wonder, is the difference between OCF (operating cash flow) and this confusing CFO?
[1] You will find a complicated explanation here: https://www.wallstreetprep.com/knowledge/reverse-dcf-model/
