Mba 504 financial management and analysis week 11

1. Read and summarize chapter 24 of the Financial Management book in at least 500 words. – Answer the following questions as well: – Explain “free cash flow.” – How is it calculated? – What is a statement of cash flow? CHP24 ; Cash Flow Analysis n objective of financial analysis is to assess a company’s operatingperformance and financial condition. The information that an analysthas available includes economic, market, and financial information. Butsome of the most important financial data are provided by the companyin its annual and quarterly financial statements. However, the choicesavailable in the accrual accounting system make it difficult to comparecompanies’ performance. These choices also provide the opportunity forthe management of financial numbers through judicious choice ofaccounting methods. For example, $1 of net income for one companymay not be equivalent to $1 of net income of another company. Cashflows provide the financial analyst with a way of transforming netincome based on an accrual system to a more comparable medium. Addi-tionally, cash flows are essential ingredients in valuation: The value of acompany today is the present value of its expected future cash flows.Therefore, understanding past and current cash flows may help the analyst in forecasting future cash flows and, hence, determine the value ofthe company. Moreover, understanding cash flow allows an analyst toassess the ability of a firm to maintain current dividends and its currentcapital expenditure policy without relying on external financing.DIFFICULTIES WITH MEASURING CASH FLOWThe primary difficulty with measuring a cash flow is that it is a flow:Cash flows into the company (cash inflows) and cash flows out of thecompany (cash outflows). At any point in time there is a stock of cashon hand, but the stock of cash on hand varies among companies becauseof the size of the company, the cash demands of the business, and a com-A24-Cash Flows Page 797 Wednesday, April 30, 2003 12:15 PM 798 FINANCIAL STATEMENT ANALYSISpany’s management of working capital. So what is cash flow? Is it thetotal amount of cash flowing into the company during a period? Is it the totalamount of cash flowing out of the company during a period? Is it the netof the cash inflows and outflows for a period? Well, there is no specificdefinition of cash flow—and that’s probably why there is so much con-fusion regarding the measurement of cash flow. Ideally, the analystneeds a measure of the company’s operating performance that is compa-rable among companies—something other than net income.A simple, yet crude method of calculating cash flow requires simplyadding noncash expenses (e.g., depreciation and amortization) to thereported net income amount to arrive at cash flow. For example, theestimated cash flow for Procter

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