What impact do net operating losses (NOLs) have on free cash flow?

Net operating losses (NOLs) significantly impact free cash flow by providing a tax shield that reduces cash taxes. When a company incurs NOLs, it can carry those losses forward (or in some cases backward) to offset taxable income in future periods. This effectively lowers the company’s tax liability when it becomes profitable again, leading to higher free cash flow as less cash is paid out in taxes.

By leveraging NOLs, a company can retain more of its earnings, which contributes positively to its overall cash flow. This aspect makes NOLs an important consideration in discounted cash flow analysis, as the forecasted free cash flows will reflect the lower cash outflows for taxes, enhancing the attractiveness of the investment.

In contrast, an increase in revenue or the classification of NOLs as a liability do not directly relate to their primary function as a tax forecasting tool. Understanding how NOLs function as a tax shield is crucial for accurately assessing their impact on free cash flow.