Question

Discuss why the longer-term generation of positive free cash flow is important to the providers of equity and debt capital. However, why is it important to take the additional step of framing the generation of free cash flow in the context of cash capital employed when performing an analysis? What questions do standardizing the free cash flow (i.e., dividing it by cash capital) enable the analyst to answer?

Answer 1

Free cash flows are those which are additional funds with a firm after meeting all its obligations like payments, expansion requirements etc. These are the surplus funds to the firms, whcih belongs to the owners of the firm. With these free cash flows, the value of a firm will be increase in the market and the shareholders value also be increases. WIth these the management will look over about future of the firm, its new ventures, new practices and any kind of expansion and so on. If a firm is having free cash flows, it means that the firm is able to fulfill all its obligations in short term and still having some additional funds with its hand. By this, we can say that the firm can become more and more stronger in financially.

Finance is the blood to any organization, and cash is the circulation of blood in the firm. Whatever the way or sources, additional funds provide additional opportunities to firm in many dimensions. It can use these funds for expansion of business, diversified, enter into new ventures, focus on short term ventures and so on. So, the management focus on generation of free cash flows in many directions which helps them to become more unlever.

If a firm is having additional funds, the first question will be are there any obligations which we need to focus immideately to the firm? If there are no obligations, then how these additional funds are going to be take care, or utilized by the management? What are the sources of these funds and what its impact on short term and long term? How the firm is going to be deal with these funds and so on.