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Finance methodology of Free Cash Flow

Author

Listed:
  • Yaari, Uzi
  • Nikiforov, Andrei
  • Kahya, Emel
  • Shachmurove, Yochanan

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.

Suggested Citation

  • Yaari, Uzi & Nikiforov, Andrei & Kahya, Emel & Shachmurove, Yochanan, 2016. "Finance methodology of Free Cash Flow," Global Finance Journal, Elsevier, vol. 29(C), pages 1-11.
    • Handle: RePEc:eee:glofin:v:29:y:2016:i:c:p:1-11
    DOI: 10.1016/j.gfj.2015.05.003
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    References listed on IDEAS

    as
    1. Petersen, Mitchell A & Rajan, Raghuram G, 1997. "Trade Credit: Theories and Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 10(3), pages 661-691.
    2. Michael Bradbury, 2011. "Direct or Indirect Cash Flow Statements?," Australian Accounting Review, CPA Australia, vol. 21(2), pages 124-130, June.
    3. Dechow, Patricia M. & Kothari, S. P. & L. Watts, Ross, 1998. "The relation between earnings and cash flows," Journal of Accounting and Economics, Elsevier, vol. 25(2), pages 133-168, May.
    4. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    5. Michael L. Lemmon & Michael R. Roberts & Jaime F. Zender, 2008. "Back to the Beginning: Persistence and the Cross‐Section of Corporate Capital Structure," Journal of Finance, American Finance Association, vol. 63(4), pages 1575-1608, August.
    6. Sheng-Syan Chen & Yong-Chin Liu & I-Ju Chen, 2014. "Long-Run Stock Performance and Its Determinants for Asset Buyers," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(5-6), pages 685-716, June.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Ali Naef Mohammad, 2016. "Valuation Tools for Determining the Value of Assets: A Literature Review," International Journal of Academic Research in Accounting, Finance and Management Sciences, Human Resource Management Academic Research Society, International Journal of Academic Research in Accounting, Finance and Management Sciences, vol. 6(4), pages 63-72, October.
    2. Ahmad A. Toumeh & Sofri Yahya & Azlan Amran, 2023. "Surplus Free Cash Flow, Stock Market Segmentations and Earnings Management: The Moderating Role of Independent Audit Committee," Global Business Review, International Management Institute, vol. 24(6), pages 1353-1382, December.
    3. Rémi Stellian & Jenny P. Danna‐Buitrago, 2020. "Financial distress, free cash flow, and interfirm payment network: Evidence from an agent‐based model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 25(4), pages 598-616, October.

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    More about this item

    Keywords

    Financial reporting; Free Cash Flow; Net Working Capital; Cost of capital; Corporate valuation; Investment decision;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • M14 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Corporate Culture; Diversity; Social Responsibility
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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