Question

Given your understanding of cash flow, financial statements, ratio analysis and time value of money, provide an example of why the integration of these concepts would be important. Do not quote the text, but think through these tools and provide an example for the others in the class as to the importance and value of these ideas when they are effectively integrated.

Answer 1

Solution:-

The tools mentioned in the question, i.e. cash flow, financial statements, ratio analysis, and time value of money are all very important tools. While they have their own solo importance, but more importantly they combine together to become even more important for various analytical and research related objectives in finance.

A classic example of the use of their integration is in the field of valuation and analysis of stocks. The valuation process involves using both DCF and relative valuation. DCF estimates the future cash flows of a business and using time value of money concept to discount those cash flows to the present time to arrive at the present worth of operations of a business. The cash flows are estimated using various items of financial statements such as revenues, expenses, capital expenditures (related to PP&E), changes in working capital (related to current assets and current liabilities), etc. Similarly, the relative valuation and peer analysis uses ratios such as EV/EBITDA, P/E, Debt to equity ratio, etc.

As can be seen all the concepts are covered in the valuation and analysis of stocks and they combine together to help investors decide which stocks they should invest in.

Hence, the example has been covered above. This example of valuation and stock analysis shows that cash flow, ratio analysis, financial statements, and time value of money effectively combine to create extremely sophisticated tools that help financial managers perform complex and useful tasks.