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Cash flow from operations is a key indicator of a company’s financial health, because without the ability
to generate cash flows from its operations, a company may not be able to survive in the future: cash
flows are the lifeblood of a company. Free cash flow
It has always been recognized that cash flow, no matter how we calculated it, does not necessarily reflect
what was available for the suppliers of capital (that is, creditors and owners). An alternative cash flow,
known as free cash flow (FCF), is useful in gauging a company’s cash flow beyond that necessary to
grow at the current rate. This is because a company must make capital expenditures to continue to exist
and to grow and FCF considers these expenditures.
In analysis and valuation, the essence of free cash flow is expressed as cash flow from operations, less
any capital expenditures necessary to maintain its current growth:
(EQ 5) Free cash flow = CFO - capital expenditures necessary
to maintain current growth Unfortunately, the amount that a company spends on capital expenditures necessary to maintain current
growth is not something that can be determined from the financial statements. Therefore, many analysts
revert to using the earlier calculation of free cash flow, using the entire capital expenditure for the
(EQ 6) Free cash flow = CFO - capital expenditures This represents the financial flexibility of the company; that is, these funds represent the ability to take
advantage of investment opportunities beyond the planned investm...
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This homework help was uploaded on 02/24/2014 for the course BUS 101 taught by Professor Lipsitz during the Spring '14 term at International University.
- Spring '14
- Behavioral Finance