21 Tying Free Cash Flows To Market Valuations

Last month, in this magazine, this author argued in Fixing Financial Statements: Financial Statement Overhaul that the traditional formats of the primary financial statements—income statement, balance sheet, and cash flow statement—need major redesign to again be useful for meaningful financial analysis, decision-making and value creation. Since the fundamental objective of a business is to increase real shareholder value, this means increasing the net present value (NPV) of the future stream of cash flows. Financial statements must, therefore, put much more emphasis on the free cash flows that a business generates. A vivid example of the different impressions one can get from focusing on profits and cash flows is Xerox Corp. (see page 18). Focusing on profits could suggest Xerox is doing well; free cash flows tell another story.