Finance methodology of Free Cash Flow

Uzi Yaari; Andrei Nikiforov; Emel Kahya; Yochanan Shachmurove

doi:https://doi.org/10.1016/j.gfj.2015.05.003

Finance methodology of Free Cash Flow

Uzi Yaari, Andrei Nikiforov, Emel Kahya, Yochanan Shachmurove

Camden School of Business

Rutgers, The State University

Research output: Contribution to journal › Article › peer-review

2 Scopus citations

Abstract

Free Cash Flow (FCF) was adopted in the late 1980s as a financial tool to evaluate the firm and its individual projects. We question the procedure of calculating the FCF where a significant portion of Current Liabilities is offset against Current Assets, thereby creating the hybrid asset Net Working Capital (NWC). Borrowed from accounting methodology, that procedure distorts the FCF size, composition, volatility, and estimated value. Our empirical analysis shows that the nature and extent of those distortions can misinform the firm's stockholders, lenders and borrowers, and investors at large. We propose a revised FCF that would avoid those distortions.

Original language	American English
Pages (from-to)	1-11
Number of pages	11
Journal	Global Finance Journal
Volume	29
DOIs	https://doi.org/10.1016/j.gfj.2015.05.003
State	Published - Feb 1 2016

ASJC Scopus subject areas

Finance
Economics and Econometrics

Keywords

Corporate valuation
Cost of capital
Financial reporting
Free Cash Flow
Investment decision
Net Working Capital

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https://doi.org/10.1016/j.gfj.2015.05.003

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abstract = "Free Cash Flow (FCF) was adopted in the late 1980s as a financial tool to evaluate the firm and its individual projects. We question the procedure of calculating the FCF where a significant portion of Current Liabilities is offset against Current Assets, thereby creating the hybrid asset Net Working Capital (NWC). Borrowed from accounting methodology, that procedure distorts the FCF size, composition, volatility, and estimated value. Our empirical analysis shows that the nature and extent of those distortions can misinform the firm's stockholders, lenders and borrowers, and investors at large. We propose a revised FCF that would avoid those distortions.",

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AU - Nikiforov, Andrei

AU - Kahya, Emel

AU - Shachmurove, Yochanan

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AB - Free Cash Flow (FCF) was adopted in the late 1980s as a financial tool to evaluate the firm and its individual projects. We question the procedure of calculating the FCF where a significant portion of Current Liabilities is offset against Current Assets, thereby creating the hybrid asset Net Working Capital (NWC). Borrowed from accounting methodology, that procedure distorts the FCF size, composition, volatility, and estimated value. Our empirical analysis shows that the nature and extent of those distortions can misinform the firm's stockholders, lenders and borrowers, and investors at large. We propose a revised FCF that would avoid those distortions.

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KW - Cost of capital

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KW - Investment decision

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Finance methodology of Free Cash Flow

Abstract

ASJC Scopus subject areas

Keywords

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