The focus on traditional financial statements is -Select- data rather than cash flow. However, cash flow is important to investors, managers, and stock analysts. Therefore, corporate decision makers and security analysts need to modify accounting data provided to them. An important modification is the concept of free cash flow (FCF). Many analysts regard FCF as being the single and most important number that can be developed from the accounting statements, even more important than net income. The equation for free cash flow is:

The focus on traditional financial statements is ACCOUNTING data rather than cash flow.

Free cash flows = (EBIT x (1 - tax rate)] + non-cash expenses (depreciation and amortization) - capital expenditures - increases in net working capital

Explanation:

Cash is KING. A company might b extremely profitable from an accounting point of view, but if it doesn't have enough cash to keep running, it will go bankrupt. E.g. many companies increase their sales revenue by handing out long credit terms to most or all of its customers including some that may not be able to pay them back. That increases accounts receivables and net income, but until the cash is collected, this is useless. The other option that a company has is to factor their accounts receivables but factoring companies are not dumb and they will pay a very low amount for them.

Companies and stocks are always valued based on cash flows, never on accounting records. Accounting records might be deceiving, but cash never lies. Either the company has or doesn't have cash. A company's cash flow tells investors how well managed a company is.

E.g. Remember that during the Great Recession both GM and Chrysler went bankrupt and the government had to bail them out. If you looked at their accounting records of the previous year, they were both profitable, so why did they burst in just a few months? They didn't have cash. Cars and SUVs are useless unless you sell them and collect the cash. Ford didn't go bankrupt because it had billions of dollars in cash, not because they were doing great. Ford was actually the company that performed worst form an accounting point of view. But out of the 3 car companies, it was the only one properly managed. Accounting records are great for the IRS but are meaningless to an investor.

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