Morningstar.com Updates Free Cash Flow Methodology

On February 20, 2025, Morningstar.com released an enhanced methodology for Free Cash Flow. Free cash flow represents a company's operating cash flow net of changes in net working capital and capital expenditures. This can be used to measure the cash a company has left over after paying interest expenses on debt and investing in the growth of its business. This is calculated using Cash Flow from Operating Activities - Changes in Net Working Capital - Capital Expenditures. It is one of the more complex financial ratios, and there are many correct ways to derive. With Morningstar’s mission of Empowering Investor Success, our analysts work to ensure we are providing our customers with the most accurate information possible.

The underlying calculation of the two methodologies is the same: Cash Flow from Operations, subtracted by reported Capital Expenditures. However, while the old methodology uses the reported values for Cash Flow from Operations from a company’s Cash Flow Statement, the new methodology is more robust as it adjusts Cash Flow from Operations to better reflect cash available to equity holders. Hence, the Cash Flow from Operations used in our new methodology is:

1. Before changes to net working capital, which is a variable number that can be easily manipulated;
2. before dividends paid, as this is cash flow that is available to equity holders, and
3. after interest expense paid, as this is a required payment to debt holders and not available to equity holders.

As a result, roughly two-thirds of the companies we cover globally will see a change in free cash flow of greater than 15%, as shown below. Specifically, companies with large swings in net working capital, a high level of dividends and/or interest expense will see the largest differences.

Percentage in Free Cash Flow Value Change/ Percentage of Companies Impacted:

• None / 10%
• <1% / 3%
• 1%-4.9% / 7%
• 5%-9.9% / 7%
• 10%-14.9% / 5%
• >15% / 68%

Examples of the changes are shown here; displayed as the Company Name/ Ticker, the % change in free cash flow and the reason:

• Fiserv Inc / FI   24%; Changes in Net Working Capital
• Coca-Cola Co / KO 9%; Changes in Net Working Capital
• Morningstar / MORN  -9%; Changes in Net Working Capital (all)
• Ford Motor Co / F -17%; Changes in Net Working Capital, Dividends Paid
• WillScot Holdings / WSC 17%; Changes in Net Working Capital, Interest Paid