Financial statements prepared according to GAAP often fail to meet the needs of statement users because they tend to emphasize accounting events at the expense of economic events and their cash effects. Transactional analysis integrates cash flow information derived from traditional accounting data with accrual information to arrive at a clearer picture of the economic events that affect the past, present and future performances of investment alternatives.
Critical to transactional analysis is the classification of operating, investing and financing events. Operating cash flow may be derived by deducting cash inputs and all cash operating expense and related income taxes from cash inflows that are by nature “operating.” Operating cash flow—the result of the period’s operations—represents cash available for investment, repayment of debt, acquisitions and other corporate purposes. The cash flow for investments may be computed by adding (subtracting) the increase (decrease) in the net property, plant and equipment accounts to (from) depreciation expense. All cash flows relating to structure may be aggregated into financing cash flow, including debt incurred or repaid, interest payments, dividends paid and equity sold or retired.
Subtracting required financing and investment outflows from operating cash flow yields free cash flow. Free cash flow and the behavior of its components provide analysts with useful information about the significant relations between economic events and the management decisions that affect those events.