What is a key reason for excluding interest expense when assessing cash flows for valuation?

When assessing cash flows for valuation, it is essential to exclude interest expense because it skews true profitability assessments. Cash flows from operations should reflect the underlying performance of the business, independent of its capital structure, including how it is financed through debt. Including interest expense introduces variability that can distort comparisons between companies, particularly those with different levels of leverage or financing arrangements.

By removing interest expense from the evaluation of cash flows, analysts can focus on the operational efficiency and profitability of the core business activities. This approach provides a clearer picture of how well the company generates cash from its operations, which is crucial for valuation purposes, as it enables more accurate assessments and comparisons within an industry or sector. This methodology aligns with the principle that cash flow should be evaluated on a similar basis, regardless of financing decisions made by the company.