Explain what Working Capital is and why it is so important. Also discuss why Cash Flow is so important to a company. Lastly, explain/define the term Free Cash Flows as found in Appendix 3A. 94 PART 1 ⚫ The Scope and Environment of Financial Management LO5 Calculate a firm's free cash flows and financing cash flows. free cash flows the amount of cash available from operations after the firm pays for the investments it has made in operating working capital and fixed assets. This cash is available to distribute to the firm's creditors and owners. Appendix 3A Free Cash Flows We can think of a firm as a group of assets that produces cash flow. Once the firm has paid all its operating expenses and made all its investments, the remaining cash flows are free to be distributed to the firm's creditors and shareholders-thus, the term free cash flows. Specifically, a company's free cash flows result from two activities: 1. After-tax cash flows from operations are the cash flows a firm generates from day-to-day operations after taxes are paid, but before any investments in work- ing capital or long-term assets are made. Think of it as the cash flows of a busi- ness if it were not getting larger or smaller in size. (You should note that when computing free cash flows, the term cash flows from operations is not the same as in the statement of cash flows presented earlier in the chapter.) 2. Asset investments, which include investments in (1) a company's net operating working capital and (2) its long-term assets. Note: Previously in the chapter, we measured net working capital as total current assets less total current liabilities. We have now changed the term to net operating working capital, where the insertion of the word operating changes our measurement. So, watch for this subtle difference as we mea- sure free cash flows. We will explain more shortly. Computing Free Cash Flows Simply stated, free cash flows are calculated as follows: Free cash flows after-tax cash flows from operations increase in less net operating or plus net operating decrease in (3-1A) [working capital working capital and less increase in long-term assets or plus decrease in long-term assets So, the procedure for computing a firm's free cash flows involves three steps: 1. Compute the after-tax cash flows from operations by converting the income statement from an accrual basis to a cash basis. (You should note when comput- ing free cash flows, the term cash flows from operations is not the same as in the statement of cash flows.) 2. Calculate the increase or decrease in the firm's investment in net operating working capital. As already mentioned, net working capital is now called net operating working capital. 3. Compute the increase or decrease in investments made in long-term assets, in- cluding fixed assets and other long-term assets, such as intangible assets. Let's look at each of the steps involved in calculating free cash flows.

Explain what Working Capital is and why it is so important. Also discuss why Cash Flow is so important to a company. Lastly, explain/define the term Free Cash Flows as found in Appendix 3A. 94 PART 1 ⚫ The Scope and Environment of Financial Management LO5 Calculate a firm's free cash flows and financing cash flows. free cash flows the amount of cash available from operations after the firm pays for the investments it has made in operating working capital and fixed assets. This cash is available to distribute to the firm's creditors and owners. Appendix 3A Free Cash Flows We can think of a firm as a group of assets that produces cash flow. Once the firm has paid all its operating expenses and made all its investments, the remaining cash flows are free to be distributed to the firm's creditors and shareholders-thus, the term free cash flows. Specifically, a company's free cash flows result from two activities: 1. After-tax cash flows from operations are the cash flows a firm generates from day-to-day operations after taxes are paid, but before any investments in work- ing capital or long-term assets are made. Think of it as the cash flows of a busi- ness if it were not getting larger or smaller in size. (You should note that when computing free cash flows, the term cash flows from operations is not the same as in the statement of cash flows presented earlier in the chapter.) 2. Asset investments, which include investments in (1) a company's net operating working capital and (2) its long-term assets. Note: Previously in the chapter, we measured net working capital as total current assets less total current liabilities. We have now changed the term to net operating working capital, where the insertion of the word operating changes our measurement. So, watch for this subtle difference as we mea- sure free cash flows. We will explain more shortly. Computing Free Cash Flows Simply stated, free cash flows are calculated as follows: Free cash flows after-tax cash flows from operations increase in less net operating or plus net operating decrease in (3-1A) [working capital working capital and less increase in long-term assets or plus decrease in long-term assets So, the procedure for computing a firm's free cash flows involves three steps: 1. Compute the after-tax cash flows from operations by converting the income statement from an accrual basis to a cash basis. (You should note when comput- ing free cash flows, the term cash flows from operations is not the same as in the statement of cash flows.) 2. Calculate the increase or decrease in the firm's investment in net operating working capital. As already mentioned, net working capital is now called net operating working capital. 3. Compute the increase or decrease in investments made in long-term assets, in- cluding fixed assets and other long-term assets, such as intangible assets. Let's look at each of the steps involved in calculating free cash flows.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter6: Accounting For Financial Management

Section: Chapter Questions

Problem 2MC

See similar textbooks