First we start with the concept of Free Cash Flows (to the firm) and then we will break this down into free cash flow to equity so we can value the firm’s stock.

In their 2009 10-K annual report Part 2, Item 7 (MD&A) IBM provided some selected discussion of free cash flows followed by a table comparing across years:

“Management uses a free cash flow measure to evaluate the company’s operating results, plan share repurchase levels, evaluate strategic investments and assess the company’s ability and need to incur and service debt. Free cash flow is not a defined term under U.S. GAAP and it should not be inferred that the entire free cash flow amount is available for discretionary expenditures. The company defines free cash flow as net cash from operating activities less the change in Global Financing receivables and net capital expenditures. As discussed on page 24, a key objective of the Global Financing business is to generate strong returns on equity.

From the perspective of how management views cash flow, in 2009, free cash flow was $15.1 billion, an increase of $0.8 billion compared to 2008. This cash performance was driven primarily by the growth in net income of $1.1 billion, lower capital spending of $0.8 billion and higher cash from sales cycle working capital ($1.2 billion), partially offset by higher retirement-related funding ($0.9 billion) and workforce rebalancing payments ($0.6 billion).

Over the past five years, the company generated over $61 billion in free cash flow. During that period, the company invested $13.8 billion in strategic acquisitions and returned over $63 billion to shareholders through dividends and share repurchases. The amount of prospective returns to shareholders in the form of dividends and share repurchases will vary based upon several factors including each year’s operating results, capital expenditure requirements, research and development investments and acquisitions, as well as the factors discussed below.”

This can be contrasted to their traditional Consolidated Statement of Cash flows constructed earlier from the Excel Workbook exported from the SEC site.

In the next section we will reconcile this directly from IBM's 2010 10-K which covers the year ending December 31, 2009.