Module I· Cash Flow Statement ConstructionAdvanced
Question
How do you treat stock-based compensation in OCF — and why is it controversial?
Answer
Mechanics
SBC is a non-cash expense → an add-back in OCF under the indirect method.
Deep diveShow more details
Consequence
OCF is reported higher than if it were paid as cash salary. Controversial because:
- SBC is economically a real expense — equity dilution costs existing shareholders.
- Tech companies report OCF inclusive of the SBC add-back, which artificially inflates 'adjusted FCF'.
Example
Salesforce reports ~$3bn of SBC a year, fully added back to OCF. IB adjustment: when running a DCF on tech companies, use 'FCF after SBC' — i.e. do NOT add SBC back, or equivalently reduce the resulting OCF by the equity-dilution cost. Among European tech: SAP reports ~$1.5bn p.a. of SBC.
Pitch tip
In a tech valuation, present 'SBC-adjusted FCF' with a 5–15% valuation difference vs. reported FCF — otherwise the senior misses the issue and it comes back in Q&A. Buyside convention: public-markets investors like T. Rowe Price and BlackRock deduct SBC.