The Correct Definition for the Cash Flows to Value a Firm (Free Cash Flow and Cash Flow to Equity)

13 Pages Posted: 30 Sep 2004

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: January 3, 2005

Abstract

Surprisingly there is a wide range of interpretations on how to calculate the cash flows for valuation purposes. This ample definition of what the cash flows are is shared by academicians and practitioners. Some of the definitions openly contradict the essential and basic concepts of cash flow and time value of money.

In this note we specify very clearly what has to be included in those cash flows and the reasons why they should be included.

The main issue is related to the inclusion or exclusion of some items in the working capital and the current practice to consider that funds that appear in the Balance Sheet (cash and market securities and the like) belong to the free cash flow FCF and the cash flow to equity CFE. In the same line of reasoning, the idea is that cash flows have to be consistent with financial statements. With a hypothetical example we show the implicit financial facts reflected in the financial statements behind the practice of including as cash flow items that appear in the Balance Sheet.

Note: The Spanish version is available at: http://ssrn.com/abstract=642664

Keywords: Cash flows, free cash flow, cash flow to equity, valuation, levered value, levered equity value, cash budget

JEL Classification: G31, G12

Suggested Citation

Velez-Pareja, Ignacio, The Correct Definition for the Cash Flows to Value a Firm (Free Cash Flow and Cash Flow to Equity) (January 3, 2005). Available at SSRN: https://ssrn.com/abstract=597681 or http://dx.doi.org/10.2139/ssrn.597681

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

Register to save articles to
your library

Register

Paper statistics

Downloads
2,991
Abstract Views
10,268
rank
3,651
PlumX Metrics