Lesson 2 of 8
Which cash flow you mean
Four defensible definitions of free cash flow on one filed year of one company, the 738 million between them, and the one error that doubles the debt.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- Four ordinary definitions of free cash flow give four different numbers for the same filed year.
- Cash flow to the firm is discounted at the cost of capital and needs net debt taken off. Cash flow to equity is discounted at the cost of equity and does not.
- Mixing the two subtracts the debt twice, and the output still looks like a valuation.
Every DCF starts from a cash flow, and "free cash flow" is not one figure. Here are four of them, all defensible, all computed from one company's filed fiscal 2026, which reported operating cash flow of 19,556 million dollars and capital expenditure of 4,409 million.
Four definitions of free cash flow, Procter and Gamble fiscal 2026
- Operating cash flow less capex · the line the filing itself carries15,147$m
- Free cash flow to the firm14,820$m
- Owner earnings14,797$m
- Free cash flow to equity14,409$m
Where each one comes from
| Definition | Built from | Discount at | Net debt |
|---|---|---|---|
| Operating cash flow less capex | 19,556 less 4,409 | Cost of capital | Subtract |
| To the firm | Operating profit after tax 15,646, plus depreciation 3,160, less capex 4,409, less the 423 released from working capital | Cost of capital | Subtract |
| Owner earnings | Net income 16,046, plus depreciation 3,160, less capex 4,409 | Cost of capital | Subtract |
| To equity | 19,556 less 4,409, less 738 of net debt repaid | Cost of equity | Do not subtract |
The first three are cash available to everyone who financed the business, lenders included, so the interest has not been taken out and the debt is subtracted at the end. The fourth is what is left after the lenders have been paid and after borrowing has been repaid or drawn, so it belongs to shareholders already.
Owner earnings is the one with a judgement in it
Buffett's 1986 definition is reported earnings plus depreciation and other non-cash charges, less the capital spending the business needs to hold its position. The last clause is the whole of it: maintenance capital spending is not a filed line. Using total capital expenditure, as the table above does, charges the growth spending against this year as well, which understates a company that is investing to expand.
The error that matters
The first three rows are the same exercise with three reasonable definitions, and they span 2.80 a share. The last two rows are the same cash flow treated two ways, and they span 49.67. The definition is worth a few percent. Matching the definition to the rate and to the debt is worth a third of the answer.
What the workbench is asking for
ValueScreener's model asks for a starting free cash flow, a discount rate and net debt, and then subtracts the net debt from the result. That tells you which definition it wants: a firm-level cash flow, discounted at a cost of capital that already blends debt and equity. Put a cash flow to equity in that box and the debt comes off a number it was already taken out of.
There is no way for the form to catch this, because 14,409 and 15,147 are both plausible figures for this company. The check is yours: write which definition you used in the same place you wrote the rate.
Check yourself
Free cash flow to the firm is discounted at which rate, and what happens to net debt?
- Cost of equity, and net debt is subtracted
- Weighted average cost of capital, and net debt is subtracted at the end
- Weighted average cost of capital, and net debt is ignored
Show the answer
Answer: B.
Cash to the firm belongs to lenders and shareholders together, so it is discounted at the blended rate, and the lenders' claim comes off the total afterwards.Why is owner earnings the definition that carries a judgement?
- Because depreciation is an estimate
- Because it subtracts maintenance capital spending, which no filing states separately
- Because net income is not a cash figure
Show the answer
Answer: B.
Filings report total capital expenditure. Splitting it into maintenance and growth is the analyst's estimate, and it moves the answer.An analyst discounts free cash flow to equity at the cost of capital and then subtracts net debt. What has gone wrong?
- Nothing, provided the growth rate is reasonable
- The debt has been charged twice, once inside the cash flow and once at the end
- The answer is too high
Show the answer
Answer: B.
Cash flow to equity is already after interest and net borrowing. Subtracting net debt again removes the same claim a second time, and the output still looks like a valuation.Sources
- Procter and Gamble, Form 10-K, fiscal year ended 30 June 2026, filed 2026-08-04, accession 0000080424-26-000103: operating cash flow, capital expenditure, operating profit, tax, depreciation, net debt issuance and the balance sheet used for the working capital movement.
- Berkshire Hathaway shareholder letter, 1986, appendix: owner earnings as reported earnings plus non-cash charges less the capital expenditure the business requires to maintain its position.
- Damodaran, Investment Valuation: matching the cash flow to the discount rate, and the double-counting that follows when they are mismatched.
What this leaves out
- The working capital movement here is computed from two filed balance sheets because the cash flow statement does not carry a single line for it.
- Maintenance capital spending is not disclosed. Owner earnings above uses total capital expenditure, which is a stated simplification and not the definition's intent.
- The effective tax rate used is this company's own filed rate for one year, which moves between years.
- Nothing here is advice about any security.