Cash Flow
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Subject: Investment Analysis
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Chapter/Topic: Financial Statement Analysis
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Concept Definition and Explanation
Disounted cash flow valuation techniques need cash flow estimates to calculate values of securities. Hence analysts have to estimate cash flows based on the financial statements pubished by companies.
Traditionally, one of the cash flow measures used by analysts based on the financial statements was net income plus depreciation expense and deferred taxes.
Now cash flow statements are made mandatory and they contain three sections:
1. Cash flow from operating activities
2. Cash flows from investing activities
3. Cash flows from financing activities.
Free Cash Flow
Free cash flow modifies the cash flow from operating activties shown in the statement of cash flows for investing and financing activities that are critical to the firm. The idea is that unless these expenditures are made, the company cannot use its cash flow for rewarding its shareholders. Two additional items capital expenditure and sales of assets are taken into account and the remaining cash flow is termed as free cash flow.
References:
Reilly, Frank and Keith Brown, Investment Analysis and Portfolio Management, 7th Edition, Thomson-South Western, 2003
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