Question

1. Describe the difference between Net Income, Net Cash Flow (from cash flow statement) and Free Cash Flow. Explain why free cash flow is the most useful metrics for investors.

Answer 1

Net Income is a financial statement which shows us how much profit is flowing year by year. Operating Income with tax and without tax is being shown. Revenues are the expenses are shown. But we cannot understand where the cash is flowing in and out with the help of Net Income. Net Cash Flow from the cash flow statement considers the cash flows from operating, investing and financing activities. Cash flows shows how much working capital is flowing into the operations, changes in the cash, accounts receivables and payable changes, and how much is financed and invested into the expansion projects etc. These details cannot be seen in Income statement. Free Cash Flow is a metric where we add Depreciation, take off Changes in Working capital , tax , capital expenditure from the Operating Income to determine how much money is set aside apart from all the business requirements.

To explain why Free Cash flow is useful to the investors, is such that we can see how much money is getting generated for each year and forecast the future with the growth rate help by making assumptions. In that way, one can invest for a longer time or for shorter time based on the growth rate and also one can decide whether the company is utilizing it's funds in an efficient manner or not.