Using the Banker’s Direct Statement of Cash Flows a) What is the most important measure? Why? b) What...

Statement of cash flows is important in determining the financial health of an enterprise by evaluating and determining the entity’s ability to increase value for its shareholders and to fulfill its financial obligations to third parties. Cash flows also show the ability of an enterprise to withstand economical downturns and remain solvent. The enterprise is not only required to generate revenues but also ensure that the cash flows in and out of the business are...

Statement of cash flows is important in determining the financial health of an enterprise by evaluating and determining the entity’s ability to increase value for its shareholders and to fulfill its financial obligations to third parties. Cash flows also show the ability of an enterprise to withstand economical downturns and remain solvent. The enterprise is not only required to generate revenues but also ensure that the cash flows in and out of the business are managed adequately.

A statement of cash flows may be analyzed based on a several measures, with each measure offering different information. The operating cash flow/sales ratio and the free cash flow/operating cash flow ratio are the first two measures you would rely on. They measure important indicators related to cash flow (which is the cash available to readily pay any day's operating and debt obligations and which is different from income).

Operating cash flow provides insights into the company’s operations and use of cash. Operating cash flow shows that the business can effectively perform daily operation activities and still provide growth and that the business has the ability to avoid excessive borrowing for operating costs. Operating cash flow (OCF) is calculated as the adjustment of net income for relevant operating costs such as increased inventory, increase or reduction in accounts receivable (which is unpaid sales revenue) and depreciation. 

Free cash flow represents the company's cash available after maintaining and expanding its asset base. Free cash flow is the cash that can be translated into increased value for the shareholders through the potential for acquisitions and new products while maintaining the ability to pay off creditors and to keep up stable dividend payouts. Free cash flow is calculated as net operating cash flows (NOCF) minus capital expenditures (investments) (CAPEX).