 Hello and welcome to the session in which we would look at financial ratios that deal specifically with the statement of cash flows and The prior session we learn how to prepare the statement of cash flows and we talked about different parts of the statement of cash flows Well, one purpose of the statement of cash flows is to help us make financial decision How do we value a company? That's important looking at the statement of cash flows and using those ratios It's going to give us better information about this company That's better decision-making in terms of investing not investing lending money to this company buying additional stocks selling our position So on and so forth Specifically, we're going to be looking at three ratios The current cash debt ratio the cash debt ratio and the free cash flow and we're going to explain what each one of these ratios Tells you as a user. So this is the purpose one of the purpose of the cash flow statement Is to give you additional information about the company now This topic is covered on the CPA exam as well as in your intermediate accounting course So it's very important that you understand this topic whether you are an accounting student or a CPA candidate I strongly suggest you take a look at my website farhatlectures.com. I don't replace your CPA review course I'm a useful addition to your CPA review course. I provide you alternative explanation Alternative resources your risk is one month of subscription. Your potential gain is passing the exam I do have resources for other accounting courses as well My CPA supplemental resources are aligned with your course directly whether you are taken Roger Wiley Gleam or Becker They are aligned with that so it's easy to go back and forth between my course and your CPA review course I also have all the previously released AI CPA exam Questions with detailed solution if you have not connected with me on LinkedIn, please do so Subscribe to my youtube like this recording share it with other connect with me on instagram facebook twitter and reddit So the first ratio we're going to look at is the current cash debt ratio What is the current cash debt ratio? Well, it's going to measure our ability If we can pay off our short term obligation our current liabilities So when we talk about current liabilities, we're looking at financial Liquidity are we liquid enough? So this ratio measures liquidity liquidity talks about the short term How is it computed? Well, it's computed by taken net cash provided by operating activities And hopefully this is positive that negative divided it by the average current liabilities And the best way to illustrate this concept is to use some numbers Let's assume 75 000 and net cash provided by operating activities to keep it also simple We have 75 000 in the average liability We have a ratio of one to one or just one a ratio of one to one is considered good It means only from your operation you can pay off all your liabilities Now companies don't pay off all their liabilities But having the ability to pay off all your current liabilities to be more specific Is a good thing you are you have a financial you have you have you are in good shape because you have financial liquidity Now the cash debt coverage is it's it measures the ability to pay all liabilities Without without restoring the selling asset or restoring to outside finances So now what we're doing we're keeping the numerator the same we're changing the denominator And the denominator we're going to say can we cover how much can we cover of our total liabilities from operating cash? Well this measure looking at the long-term perspective of the company because the company don't plan to pay off all its debt Right and if it can pay off all its debt They will not even borrow money in the first place if they cannot pay off all that debt from operating activities So this measure the financial flexibility how flexible the company in the long run Okay, so it's computed by taking net cash provided by operating activities And we're going to assume the number is 75 An average total liability will we're going to make the number 150 so this is the ratio is 0.5 It means from operating activities if we want to pay off all our liabilities We can pay half of our liabilities again. No companies pay off all their liabilities, but We want to see A larger number so rather than 0.5. We prefer 0.6. We prefer 0.7. Okay Obviously if it's one to one that's excellent It means just from operating the business in one particular year We can pay off all our liabilities that will be great the higher the better. I just gave you this example Again ratios will be have to be taken into perspective always you have to compare it to prior period competitors so on and so forth and the most interesting ratio is the free and not ratio the most interesting indicator something called free cash flow and this is not really a ratio This is basically a computation Computation to figure out the discretionary cash. How much discretionary cash does the company have? What's discretionary cash? Well, that's a good thing discretionary means you can do anything with that cash Anything you would like to this also Measures your financial flexibility like the cash that coverage you have flexibility to do things now How do we measure this free cash flow? Well, we're gonna take cash from operating activities. Hopefully it's positive If it's negative. It's useless and we're gonna deduct from it any capital expenditure Here what we mean by capital expenditure is things we need to invest in the business to keep on going to keep on operating Think of them as required capital expenditure other the company otherwise the company will deteriorate So let's assume our our net operating cash is 75,000 and based on our need We have 30,000 of capital expenditure for that particular year Then we are required not required but in quote we have to satisfy the shareholders pay them some dividend Otherwise they would leave the company. We're gonna pay them 10,000 if that's the case. We are left with 45,000 we call the 45,000 is the leftovers or Free cash flow or discretionary cash and this is good. You want this number to be positive Basically now we have this number of 45,000 we can do practically anything with it anything we want to because From from operating the company. We satisfy the capital expenditure. We satisfy the shareholders What can we do now with this money? We can do many things. We can make additional investments like buy other investments discretionary investments We can buy back treasury stock and even satisfy the shareholders better We can pay off some debt Why not now we can do anything with this cash? So when we invest in a company when when you invest in a company You want to know what's their free cash flow because the free cash flow This is for you. Basically. This is like the the icing on the cake. This is what you know The investors can use you can tell them to buy back treasury stock pay off the debt Let's remove the the debt interest expense So you want to have a positive free cash flow not negative in other words if you have negative It means from operating you cannot satisfy the capital expenditure and the dividend Now at the end of this recording again I'm going to invite you whether you are an accounting student or a cpa candidate to take a look at my website And consider investing in your career. I do have resources for various accounting courses for your cpa exam The cpa exam is worth it