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Cash Flow Analysis and Forecasting: The Definitive Guide to Understanding and Using Published Cash Flow Data by Timothy Jury

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17

Summarising Historic Free Cash Flow

This chapter deals with the identification and analysis of the historic free cash flows of a business. Before we commence the actual process of analysis it is probably useful to offer some brief contextual remarks to those readers who are less familiar with the fundamentals of corporate finance theory.

THE ORIGIN OF FREE CASH FLOW

In the last 50 years we have seen the development of a new methodology for assessing the value of a project, based on the idea of forecasting and then discounting the future cash flows relating to the project to arrive at the present value of the project. Sometime later it was recognised that this method could also be used to arrive at the valuation of a business (this in turn coming from the insight that a business can be viewed as a bunch of projects in various stages of their life cycles).

In order to complete the process of valuing a business in this way it is typical to forecast the future free cash flows of the business a number of years into the future and then discount them using an estimate of the businesses cost of capital; the resulting annual free cash flow values then being summed.

The estimated cash flows after the forecast period are dealt with by assuming they represent a perpetuity of some kind, the value which is, in turn, also discounted to find its present value. The resulting value is known as the residual value.

As this is a forecasting exercise the process of completing this is dealt with ...

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