Here's a bit of good news regarding the economy: top-line growth, rather than just cost-cutting, is driving free cash margin at nearly 3,000 companies with market caps of at least $50 million. The median free cash margin across these firms inched up from 4.41 percent for the 12 months ending September 2011, to 4.54 percent for the year ending in December 2011. These numbers are solidly above the 2.43 to 3.96 percent seen during the recessions in 2001 and 2008. "In effect, revenue growth is enabling companies to increase spending without negatively impacting their generation of free cash flow," according to a report from the Financial Analysis Lab at Georgia Tech.
The current results run almost counter to what might have been expected. As the report notes, it's not unusual for free cash margin to drop as an economy recovers, since companies start spending again on inventory and capital investments. In the most recent analysis, revenue growth made the increase in free cash margin possible.
The folks at Georgia Tech arrive at free cash margin by dividing free cash flow by revenue. The number indicates the percent of revenue available after expenses, and that can be used for shareholder dividends, M&A, or debt retirement, without hindering the company's ability to generate yet more cash. It is one indicator of a company's financial health.
A number of factors contributed to the change in free cash margin. Median revenues jumped 5.35 percent, from $675 million in September to $711 in December, continuing a trend that really took off starting in March 2011. Even as revenues rose, companies were able to cut -- albeit slightly -- sales, general and administrative (SG&A) costs; these dropped from 20.31 percent to 19.84 percent of revenue between September and December 2011. Accounts receivable days dropped from 51.99 days in September to 50.32 days in December -- a sign that companies were able to collect moneys owed them a bit more quickly.
Working against the increase in free cash flow was a slight jump in capital expenditures, which increased slightly, rising from 3.29 percent to 3.41 percent. At the same time, companies' operating cushion declined slightly, dropping from 16.02 percent to 15.89 percent over the same time period.
While free cash flow was stable at the companies in 31 industries in the analysis, and dropped across ten industries, it rose significantly within three: fabricated products, defense and business services. For example, free cash margin among fabricated products companies more than tripled between the 12-month periods ending in September and December 2011, rising from 1.87 to 5.91 percent. It nearly doubled in the defense industry, rising from 5.53 to 10.14 percent for the years ending September and December 2011.
Among the industries with declining free cash margin were several that have struggled over the past few years, including construction, construction materials, and printing/publishing.
Even so, the overall level of free cash margin now is similar to the levels seen before the last recession. Moreover, as the report notes, because many firms are sitting on cash stockpiles -- according to FactSet Research Systems Inc., cash and short-term investments among the S&P 500 (excluding financials) topped $1.2 trillion at year-end 2011 -- they can continue to invest in operations.
One possible future drag on free cash margin would be a jump in capital investments, which currently remain below historical levels.