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Encyclopedia of Financial Models, 3 Volume Set by Frank J. Fabozzi

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Cash-Flow Analysis

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance, College of Business, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor of Finance, EDHEC Business School

Abstract: An objective of financial analysis is to assess a company's operating performance and financial condition. The information that is available for analysis includes economic, market, and financial information. But some of the most important financial data are provided by the company in its annual and quarterly financial statements. These choices make it quite difficult to compare financial performance and condition across companies, and also provide an opportunity for the management of financial numbers through judicious choice of accounting methods. Cash flows provide a way of transforming net income based on an accrual system to a more comparable basis. Additionally, cash flows are essential ingredients in valuation: The value of a company today is the present value of its expected future cash flows. Therefore, understanding past and current cash flows may help in forecasting future cash flows and, hence, determine the value of the company. Moreover, understanding cash flow allows the assessment of the ability of a firm to maintain current dividends and its current capital expenditure policy without relying on external financing.

One of the key financial measures that an analyst should understand is the company’s cash flow. This is because the cash flow aids the ...

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