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Define cash flows from operations (CFO)
Relating to most income statement activities
essential to the long-term viability of the company
Excludes gains and losses--result from financing and investing activities
What activities are included under GAAP as useful for valuing equity but are excluded as useful for valuing the firm?
Cash received from interest--CFI
Cash received from dividends--CFI
Cash paid for interest--CFF
Define cash flows from investing activities (CFI)
Arise from the purchase and sale of noncurrent assets
Currents assets are sometimes included if they are non-operating accounts (Example
: short-term investments in securities)
Define cash flows from financing activities (CFF)
Arising from the issuance and retirement of interest-bearing debt, issuance and buybacks of stock, and dividend payments
What is the free cash flow formula and modified free cash flow formula?
FCF = CFO - Net Capital Expenditures (CFI) <--useful for valuation of equity
FCF' = CFO' - CFI' <-- useful for valuing the firm
calculate CFI' by adding back cash collected for interest and subtracting cash paid for interest.
Adjust CFO' accordingly as well.
What is the indirect method?
More common method
Starts with net income and adjusts for accruals and deferrals (example
: add back depreciation expense)
What is the direct method?
FASB recommended format
each line item on the income statement is converted to a cash basis
Financial Statement Analysis