Finance / July 18, 2018 / Hattie Munoz
Free cash flow is an important measurement since it shows how efficient a company is at generating cash. Investors use free cash flow to measure whether a company might have enough cash, after funding operations and capital expenditures, to pay investors through dividends and share buybacks.
Amortization is like depreciation, which is used for tangible assets, and depletion, which is used for natural resources. When businesses amortize expenses, it helps tie the asset's costs to the revenues it generates. For example, if a company buys a ream of paper, it writes off the cost in the year of purchase and generally uses all the paper the same year. Conversely, with a large asset, the business reaps the rewards of the expense for years. Thus, it writes off the expense incrementally over the useful life of that asset, tangible or intangible.
Changes in Working Capital is reported in the cash flow statement since it is one of the major ways in which net income can differ from operating cash flow. Under the accruals system, companies calculate revenue and expenditure when a transaction occurs instead of when the cash actually changes hands.
This focus makes EBIT an especially useful metric for certain applications. For example, if an investor is thinking of buying a firm out, the existing capital structure is less important than the company's earning potential. Similarly, if an investor is comparing companies in a given industry that operate in different tax environments and have different strategies for financing themselves, tax and interest expenses would distract from the core question: how effectively do these companies generate profits from their operations.
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