{"id":20198,"date":"2021-08-22T07:29:30","date_gmt":"2021-08-22T07:29:30","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=20198"},"modified":"2024-04-05T11:29:59","modified_gmt":"2024-04-05T11:29:59","slug":"definitions-of-cash-flow","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/definitions-of-cash-flow\/","title":{"rendered":"Definitions of Cash Flow"},"content":{"rendered":"<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/0kMmbenpFuo\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><\/iframe><\/p>\r\n\r\n<p>There are various proxies for cash flow that may be used when calculating cash flow multiples.<\/p>\r\n<h2>EPS Plus Non-Cash Charges<\/h2>\r\n<p>It is calculated as:<\/p>\r\n<p>$$ \\begin{align*} \\text{EPS Plus Non-Cash Charges}  &#038; = \\text{EPS}+\\text{Depreciation} \\\\ &#038; +\\text{Amortization}+\\text{Depletion} \\end{align*} $$<\/p>\r\n<p>A limitation of this is that it ignores non-cash revenues and changes in working capital.<\/p>\r\n<h2><span lang=\"EN-US\">Cash Flow from Operations (CFO)<\/span><\/h2>\r\n<p>This is derived from the cash flow statement and represents the amount of cash a company generates from carrying out its operating activities over a period of time.<\/p>\r\n<p>It is calculated as:<\/p>\r\n<p>$$ \\begin{align*} \\text{Cash flow from operations}&#038;= \\text{Net income}+\\text{Non-cash charges} \\\\ &#038;+\\text{Changes in working capital} \\end{align*} $$<\/p>\r\n<p>CFO may require adjustments for nonrecurring items. In addition, adjustments may be required when comparing companies that use different accounting standards. For example, dividends may be classified as operating or investing activities under IFRS and only as operating activities under US GAAP.<\/p>\r\n<h2><span lang=\"EN-US\">Free Cash Flow to Equity (FCFE)<\/span><\/h2>\r\n<p>It is calculated as:<\/p>\r\n<p>$$\\text{FCFE}=\\text{CFO}-\\text{FCInv}+\\text{Net borrowing}$$<\/p>\r\n<p>FCFE is the most valid poxy for cash flow but also the most volatile.<\/p>\r\n<h2><span lang=\"EN-US\">EBITDA<\/span><\/h2>\r\n<p>It is calculated as:<\/p>\r\n<p>$$\\text{EBITDA}=\\text{EBIT}+\\text{Depreciation and amortization}$$<\/p>\r\n<p>It is more appropriately used to value the entire firm rather than the equity component as it represents the cash flows available to both equity and bondholders.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following is <em>most likely<\/em> a limitation of using EPS plus non-cash charges as a proxy for cash flow?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>Its volatility.<\/li>\r\n\t<li>It ignores non-cash revenues.<\/li>\r\n\t<li>It is more appropriately used to value the entire firm.<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is B.\u00a0<\/strong><\/p>\r\n<p>A significant limitation of EPS plus non-cash charges is that it ignores non-cash revenues and changes in working capital.<\/p>\r\n<p><strong>A is incorrect.\u00a0<\/strong>Volatility is a drawback of using FCFE as a proxy for cash flow but not EPS plus non-cash charges.<\/p>\r\n<p><strong>C is incorrect.\u00a0<\/strong>EPS plus non-cash charges are used t value the equity component of the firm as cash available to the debt holder is already deducted.<\/p>\r\n<\/blockquote>\r\n<p>Reading 25: Market-Based Valuation: Price and Enterprise Value Multiples<\/p>\r\n<p><em>LOS 25 (m) Explain alternative definitions of cash flow used in price and enterprise value (EV) multiples and describe limitations of each definition.<\/em><\/p>\r\n","protected":false},"excerpt":{"rendered":"<p>\ufeff\ufeff There are various proxies for cash flow that may be used when calculating cash flow multiples. EPS Plus Non-Cash Charges It is calculated as: $$ \\begin{align*} \\text{EPS Plus Non-Cash Charges} &#038; = \\text{EPS}+\\text{Depreciation} \\\\ &#038; +\\text{Amortization}+\\text{Depletion} \\end{align*} $$ A&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102],"tags":[216,487,402,474],"class_list":["post-20198","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","tag-cfa-level-2","tag-definitions-of-cash-flow","tag-equity-valuation","tag-reading-29-market-based-valuation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Definitions of Cash Flow - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Learn about various proxies for cash flow in valuation, including EPS plus non-cash charges, CFO, FCFE, and EBITDA.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/definitions-of-cash-flow\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Definitions of Cash Flow - 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