Question

7. How is a free cash flow different from a regular cash flow? What is a statement of cash flow? What questions about cash are answered by the statement of cash flows?

Answer 1

How is a free cash flow different from a regular cash flow?

Cash Flow (What is a statement of cash flow?)

Cash flow is the net amount of cash and cash equivalents being transferred into and out of a company. Positive cash flow indicates that a company's liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders and pay expenses. Cash flow is reported on the cash flow statement, which contains three sections detailing activities. Those three sections are cash flow from operating activities, investing activities and financing activities.

Free Cash Flow

Free cash flow (FCF) is the cash a company produces through its operations after subtracting any outlays of cash for investment in fixed assets like property, plant and equipment. In other words, free cash flow or FCF is the cash left over after a company has paid its operating expenses and capital expenditures.

Free cash flow shows how effectively a company generates and uses its cash. Free cash flow is used to measure whether a company has enough cash, after funding operations and capital expenditures, to pay investors through dividends and share buybacks. To calculate FCF, we would subtract capital expenditures from cash flow from operations.

By comparing cash flow to free cash flow, investors can gain a better understanding of where cash is coming from and how the company is spending their cash. For example, a company may have a stockpile of cash; at first glance, that may appear to be a good sign. However, under closer inspection, we might uncover that the company has taken on a sizable amount of debt that it does not have the cash flow to service.

By analyzing both cash flow and free cash flow, we can see how much a company generates from their normal course of operations, what they're investing in and how much debt they're paying down or taking on. As a result, investors can make a more informed decision as to the financial viability of the company and its ability to pay dividends or repurchase shares in the upcoming quarters.

What questions about cash are answered by the statement of cash flows?

The statement of cash flows shows all changes to the cash account during a period of time. The Cashflow statement cash segregates the transactions into three categories of operating, investing and financing. The Cashflow statement indicates the relationship between net income and cash flows from operations and identifies non-operating sources and use of cash.