Respond to 2 peers
-What are the four statements contained in most annual reports?
The first financial statement is a balance sheet, which summarizes the organization’s financial position. A balance sheet provides a list of all the organization’s assets, liabilities, and equity owned by stakeholders. The assets listed are either current assets, such as cash and stock inventory, or fixed assets, such as buildings, equipment, and land. Examples of liabilities that an organization may list include taxes and wages. A balance sheet helps evaluate an organization’s ability to meet its long-term financial commitments (Felber et al., 2019). The second financial statement is an income statement, and it summarizes the amount of money earned and spent by an organization in a financial year. Earnings are derived from the revenue, such as sales and interests, while money spent is delivered from incurred expenditures such as purchases. The third financial statement is a cash flow statement, and it explains the source of capital and how it was spent in that specific financial year. The fourth financial statement is the equity statement or statement of retained earnings. It indicates shareholders’ equity at the beginning of a particular year, investments in the business, and the net income acquired.
-What is free cash flow?
It represents the amount of cash generated by a business after accounting for reinvestment in non-current capital assets by the company. It is calculated by subtracting Capital Expenditures from the Cash from Operations (Ketz, 2016).
-Why is it the most important measure of cash flow?
Free cash flow (FCF) is the most important measure of cash flow since it monitors the amount of cash left over after capital expenditure.
Felber, C., Campos, V., & Sanchis, J. R. (2019). The common good balance sheet, an adequate tool to capture non-financials?. Sustainability, 11(14), 3791.
Ketz, J. E. (2016). Free cash flow and business combinations. The CPA Journal, 86(11), 48-53.
Annual reports contain a balance sheet, income statement, statement of shareholders’ equity, and statement of cash flows. The balance sheet provides a snapshot of the financial position of the company on the last day of the reporting period. The income statement reports the performance of the company during the reporting period. The statement of shareholders’ equity reports any changes during the reporting period. Finally, the statement of cash flows separates the cash activities into three categories: operating, investing, and financing, then provides a cash balance. (Brigham & Ehrhardt, 2020).
Free cash flow is the intrinsic value of a business. It is determined by the cash flow stream generated by operating activities that investors expect to receive currently and in the future. (Brigham & Ehrhardt, 2020). It is the most important measure of cash flow for many reasons. It is an indication of the likelihood that the company would be able to make their dividend payments. If the free cash flow exceeds the dividends, this indicates that there will be the potential for greater dividends in the future and makes the company look more attractive to investors. Free cash flow can also indicate the ability of a company to repay its debts, thus making them more attractive to creditors. Banks may be more apt to lend money to a company with positive free cash flow. (The Investopedia Team, 2021).
Brigham, E. F., & Ehrhardt, M. C. (2020). Financial management: Theory & practice. Cengage.
The Investopia Team (4 March 2021). Free Cash Flow vs. Operating Cash Flow: What’s the Difference? Investopia. https://www.investopedia.com/ask/answers/111314/whats-difference-between-free-cash-flow-and-operating-cash-flow.asp
The four financial statements often contained in most annual reports are the Balance Sheet, Income Statement (also referred to as statement of operations), Statement of Cashflows, and Statement of Shareholder’s equity. The four financial statements paint a picture of the financial health of the company at a given date. The Balance Sheet shows the assets, liabilities and equity of the company and helps to paint a picture of the relative health of the company by showing relationships between the companies assets and obligations. The income statement shows financial performance from operations and its relative profitability. Whereas the Statement of Cashflows shows the in and outflows of cash during a period and where cash was used. Lastly, the Statement of Shareholder Equity tracks the equity or surplus in the company and helps to show the financial health or perhaps amounts available for dividends.
Free cash flow is cash flow available for investment opportunities after operating expenses and other financial obligations such as taxes, debt obligations, etc.
Free cash flow is an important measure of cash flow because it represents the ability of the company to take advantage of opportunity, to pivot into a new market, to pay for unbudgeted and unexpected expenses or survive a catastrophic event.