Free Cash Flow to Firm (FCFF)
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The free cash flow to firm formula is capital expenditures and change in working capital subtracted from the product of
earnings before interest and taxes (EBIT) and one minus the tax rate(1-t).
The free cash flow to firm formula is used to calculate the amount available to debt and equity holders.
Variables of the FCFF Formula
Earnings before interest and taxes, EBIT, is, as it suggests, the earnings from a company’s operations before
adjusting for interest expense and taxes. EBIT can be found on the company’s income statement or calculated from the
cash flow statement. The free cash flow to firm formula does adjust for taxes by multiplying EBIT by one minus the tax
Capital expenditures (Capex) is the capital used to fund operations in the long run. Capital expenditures can be
found on a company’s cash flow statement.
Working capital is capital used to fund operations in the short run. Working capital is current assets minus current
liabilities. As opposed to longer term capital expenditures, working capital connotes expenses due within one year or less. The
change in working capital can be calculated using a company’s balance sheet.
FCFF Formula vs. FCFE Formula
Free cash flow to firm differs from free cash flow to equity in that it calculates the amount available to both debt and
equity holders, as opposed to simply equity holders. One part of how this difference is shown in the free cash flow to firm
formula is by instead of using net income, EBIT adjusted for taxes is used. This allows interest expenses to be
included as they are paid to debt holders.
Another difference between FCFF and FCFE is that the free cash flow to firm formula does not subtract out
change in debt. As with other differences listed above, this difference is applied in order to include the amount available to
Use of the FCFF Formula
As stated in the prior section, the free cash flow to firm formula is used to determine how much debt and equity holders
have available. Apart from this general use of the free cash flow to firm, it may also used in valuation models for a company’s
stock using the FCFF approach to discounting future cash flows. In this approach, FCFF is used in place of
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FCFF or Free Cash Flow to Firm is one of the most important concept in Equity Research and Investment Banking firms .
Warren Buffet (1992 annual report) said
The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset.
Warren Buffet has been focusing on company’s ability to generate Free Cash Flow to Firm. Why does this really matter? This article will focus on understanding what “Free Cash Flows” are in general and why FCFF should be used to measure company’s operating performance. This article is structured as per below –
- What is Free Cash Flow to firm or FCFF
- Layman’s Definition of Free Cash Flow
- FCFF Formulas – Analyst’s formula
- FCFF Example in Excel
- Analysis of Alibaba’s FCFF (positive FCFF and growing firm)
- Analysis of Box FCFF (negative FCFF and growing firm)
- Why does Free Cash Flow to Firm (FCFF) matters
Here we discuss FCFF, however, if you want to know more about FCFE, you can look at Free Cash Flow to Equity .
If you want to learn Equity Research professionally, then you may want to look at 40+ video hours of Equity Research Course
#1 – What is Free Cash Flow to Firm or FCFF
In order to gain an intuitive understand of Free Cash Flow to Firm (FCFF), let us assume that there is a guy named Peter who started his business with some initial equity capital (let us assume $500,000) and we also assume that he takes a bank loan of another $500,000 so that his overall finance capital stands at $1000,000 ($1 million).
- The business will begin earning revenues and there would be some associated expenses.
- As for all the businesses, Peter’s business also requires constant maintenance capital expenditure in assets each year.
- Debt Capital Raised in year 0 is $500,000
- Equity Capital raised in year 0 is $500,000
- There is no cash flow from operations and cash flow from investments as the business is yet to start
FCFF – Free Cash Flow Video
Scene # 1 – Peter’s Business with not enough earnings
- We assume that the business has just started and generates a modest $50,000 in year 1
- Cash flow from Investments in Assets is higher at $800,000
- Net Cash position at the end of the year is $250,000
- Let us now assume that Peter’s business generated only $100,000 in Year 2
- In addition, in order to maintain and run the business, he needs to regularly invest in assets (maintenance capex) of $600,000
- What do you think will happen in such a situation? Do you think the Cash at the beginning of the year is sufficient?- NO.
- Peter will need to raise another set of capital – this time let us assume he raises another $250,000 from the bank
- Now let us analyze a stressed situation for Peter 🙂 . Assuming that his business is not doing well as expected and was able to generate only $100,000
- Also, as discussed earlier, maintenance capital expenditure cannot be avoided, Peter must spend another $600,000 to keep the assets running.
- Peter will require another set of external funding to the tune of $500,000 to keep the operations running
- Debt financing of another $250,000 at relatively higher rate and Peter invests another $250,000 as equity capital
- Again in year 4, Peter’s business was able to generate only $100,000 as cash flows from operations
- Maintenance capital expenditure (unavoidable) is at $600,000
- Peter requires another set of funding of $500,000. This time, let us assume that he doesn’t have any amount as equity capital. He again approaches the bank for another $500,000. However, this time the bank agrees to give him loan at a very high rate (given the business is not in good shape and his earnings are uncertain)
- Yet again, Peter was only able to generate $100,000 as cash flows from core operations
- Capital expenditure that is unavoidable still stands at $600,000
- This time the Bank declines to given any further loan!
- Peter is unable to carry forward the business for another year and files for bankruptcy!
- After filing for bankruptcy , Peters business assets are liquidated (sold) at $1,500,000
How much the bank receives?
Bank has given a total loan of $1500,000. Since Bank has the first right to recover their loan amount, the amount received on liquidation will be first used to serve the Bank and Peter will receive the remaining excess amount (if any). In this case, Bank was able to recover their invested amount as the liquidation value of Peter’s Asset is at $1,500,000
How much Peter (shareholder) receives?
Peter has invested his own capital (equity) of $750,000. In this case Peter receives no money as all the liquidated amount goes to the serving of the bank. Please note the the return to the shareholder (Peter) is zero.
Scene # 2 – Peter’s Business Grows and show’s recurring earnings
Let us now take another case study where Peter’s business is not doing bad and is infact growing each year.
- Peter’s business steadily grows from CFO of $50,000 in year 1 to CFO of 1,500,000
- Peter raises only $50,000 in year 2 due to liquidity requirements
- Thereafter he does not need any other set of cash flow from financing to “survive” the future years
- Ending cash for Peter’s Company grows to $1350,000 at the end of year 5
- We see that excess cash is positive (CFO + CFI) from year 3 and is is growing every year.
How much the bank receives?
Bank has given a total loan of $550,000. In this case, Peter’s business is doing well and generating positive cash flows, he is able to payoff the bank loan along with the interest within the mutually agreed time frame.
How much Peter (shareholder) receives?
Peter has invested his own capital (equity) of $500,000. Peter has 100% ownership in the firm and his equity return will now depend on the valuation of this business that generates positive cash flows.
# 2 – Layman’s Definition of Free Cash Flow to Firm (FCFF)
In order to appreciate the layman’s definition of Free Cash Flow to firm or FCFF, we must do a a quick comparison of Case Study 1 and Case Study 2 (discussed above)
|Item||Case Study 1||Case Study 2|
|Revenues||Stagnant, not growing||Growing|
|Cash flow from operations||Stagnant||Increasing|
|Excess Cash (CFO + CFI)||Negative||Positive|
|Trend in Excess Cash||Stagnant||Increasing|
|Requires Equity or Debt to business continuity||yes||No|
|Equity Value / Shareholder’s Value||Zero or very low||More than Zero|
Lessons from the two case studies
- If excess cash (CFO + CFI) is positive and growing, then the company has value
- If Excess Cash (CFO + CFI) is negative for an extended period of time, then the return to the shareholder may be very low or closer to zero
Intuitive Definition of Free Cash Flow to firm – FCFF
Broadly speaking “Excess Cash” is nothing but Free Cash Flow to Firm or FCFF calculation. DCF valuation focuses on the cash flows generated by the Operating Assets of the business and how it maintains those assets (CFI).
FCFF formula = Cashflows from operations (CFO) + Cashflows from Investments (CFI)
A business generates cash through its daily operations of supplying and selling goods or services. Some of the cash has to go back into the business to renew fixed assets and support working capital. If the business is doing well, it should generate cash over and above these requirements. Any extra cash is free to go to the debt and equity holders. The extra cash is known as Free Cash Flow to firm
#3 – Free Cash Flow – Analyst’s Formula
Free Cash Flow to firm formula can be represented in the following three way –
1) FCFF Formula starting with EBIT
Free Cash Flow to Firm or FCFF Calculation = EBIT x (1-tax rate) + Non Cash Charges + Changes in Working capital – Capital Expenditure
|EBIT x (1-tax rate)||Flow to total capital, Removes capitalization effects on earnings|
|Add: Non Cash Charges||Add back all non cash charges like Depreciation, Amortization|
|Add: Changes in working capital||Can be outflow or inflow of cash. Watch for large swings year-to-year in forecasted working capital|
|Less: Capital expenditure||Critical to determine CapEx levels required to support sales and margins in forecast|
2) FCFF formula starting with Net Income
Net Income + Depreciation & amortization + Interest x (1-tax) + changes in Working Capital – Capital Expenditure
3) FCFF Formula starting with EBITDA
EBITDA x (1-tax rate) + (Dep & Amortization) x tax rate + changes in Working Capital – Capital Expenditure
I will leave it to you to reconcile one formula with the other one. Primarily you can use any of the given FCFF formulas. As an Equity analyst, i found it easier to use the formula that started with EBIT.
Additional notes on FCFF Formula Items
- Net income is taken directly from the Income statement.
- It represents the income available to shareholder’s after taxes, depreciation , amortization, interest expenses and the payment to preferred dividends
Non Cash Charges
- Non cash charges are items that affect net income but do not involve the payment of cash. Some of the common non-cash items are listed below
|Non-cash items||Adjustment to Net Income|
|Restructuring charges (expense)||Addition|
|Reversal of restructuring reserve (income)||Subtraction|
|Amortization of bond discount||Addition|
|Amortization of bond premium||Subtraction|
After tax Interest
- Since interest is tax deductible, after-tax interest is added back to the net income
- Interest cost is a cash flow to one of the stakeholder’s of the firm (debt holders) and hence, it forms a part of FCFF
- Investment in fixed assets is the cash outflow required for the company to maintain and grow its operations
- It is possible that a company acquires assets without expending cash by using stock or debt
- Analyst should review the footnotes, as these asset acquisitions may not have used cash and cash equivalents in the past, but may affect the forecast of future Free Cash Flow to Firm
Change in Working Capital
- The working capital changes that affect FCFF are items such as Inventories, Accounts Receivables and Accounts Payable .
- This definition of working capital excludes cash and cash equivalents and short-term debt (notes payable and the current portion of long term debt payable).
- Do not include non-operating current assets and liabilities, e.g. dividends payable etc
# 4 – FCFF Example in Excel
With the above understanding of the formula, let us now look at the working example of calculating Free Cash Flows to firm. Let us assume that you have been provided the Balance Sheet and Income Statement for a company as provided below. You can download the FCFF Excel Example here
Calculate FCFF (Free Cash Flow to Firm) for the year of 2008
Let us try to solve this problem using the EBIT approach.
FCFF Formula = EBIT x (1-tax) + Dep & Amort + Changes in Working Capital – Capital Expenditure
EBIT = 285, tax rate is 30%
EBIT x (1-tax) = 285 x (1-0.3) = 199.5
Depreciation = 150
Changes in Working Capital
Capital Expenditure = change in Gross Property Plant and Equipment (Gross PPE) = $1200 – $900 = $300
FCFF calcuation = 199.5 + 150 – 75 – 300 = -25.5
Calculating Free Cash Flow to Firm is fairly straightforward. Why don’t you calculate FCFF using the other two FCFF formulas – 1) Starting with Net Income 2) Starting with EBITDA
#5 – Alibaba FCFF – Positive and Increasing FCFF
On 6th May, 2014, Chinese E-commerce heavyweight Alibaba filed registration document to go to public in the US in what maybe the mother of all Initial Public Offerings in the US history . Alibaba is a fairly unknown entity in the US and other regions, though its massive size is comparable or even bigger than Amazon or eBay. I used Discounted Cash Flow approach for Alibaba’s valuation and found that this amazing company is valued at $191 billion dollars!
For Alibaba DCF, I had done the financial statement anaylsis and forecast financial statements and then calculate Free Cash Flow to the Firm. You can download Alibaba Financial Model here
Presented below is the Free Cash Flow to Firm of Alibaba. The Free Cash flow tisirm are divided into two parts – a) Historical FCFF and b) Forecast FCFF
- Historical Free Cash Flow to Firm is arrived at from the Income Statement, Balance Sheet and Cash Flows of the company from its Annual Reports
- Forecast Free Cash Flow to Firm calculation is done only after forecasting the Financial Statements (we call this as preparing the Financial Model ) Financial Modeling fundamentals is slightly tricky and I will not discuss the details and types of Financial Models in this article.
- We note that Alibaba’s Free Cash Flow to firm are increasing year after year
- In order to find the valuation of Alibaba, we must find the present value of all the future financial years (till perpetuity – Terminal value )
#6 – Box FCFF – Negative and Growing
On 24th March,2014, Online storage company Box filed for an IPO and unveiled its plans to raise US$250 million. The company is in race to be build the largest cloud storage platform and it competes with the biggies like Google Inc and its rival, Dropbox. In case you want to understand further on how Box is valued, please refer to my article on Box IPO Valuation
Below are the projections of Box FCFF for the next 5 years
- Box is a classic case of high growth cloud company which is surviving due to Cash Flow from Financing (refer Case Study # 1)
- Box is growing at a very fast pace and should be able to generate Free Cash Flows going forward.
- Since Box Free Cash Flow to Firm is negative for the next 5 years, it may not be wise for us to calculate the value of Box using the Discounted Cash Flow approach. In this case approach using the Relative Valuation is suggested.
- I am rather scared of this IPO and infact wrote an article on Top 10 Scariest Details of Box IPO . Please note that one of the scariest details in Box IPO is company’s Negative Free Cash Flow.
# 7 – Why does Free Cash Flows Matter
- EPS can be tweaked but Free Cash Flow to Firm can’t – Though EPS is widely used to measure company’s performance, however, EPS can be easily tweaked (due to accounting policies gimmicks) by the management and may not necessary be the best measure for performance. It is best advised to use a measure which is free from accounting gimmicks. Free Cash flow to firm can be one such measure which cannot be manipulated by Accounting Changes.
- Cannot go bust soon if Free Cash Flow to Firm positive and growing – Companies that produce consistently higher and growing levels of Free Cash Flows to firm are unlikely to go bust any time soon and investors should take this into account while investing in the firm.
- Good indicator for Investors seeking Capital Appreciation – For growth-oriented investors, companies with high Free Cash Flows to firm are likely to invest their free cash for the capital expenditures that are necessary to grow their core business . Growing levels of Free Cash Flows are generally an excellent indicator of future earnings gains.
- Good indicator for Investors seeking Regular dividends – For income investors, Free Cash Flows can be a reliable indicator of a company’s ability to maintain its dividend or even increase its payout.
Now that you know Free Cash flow to firm, What about FCFE – Free Cash flow to Equity? Checkout a detailed article on Free Cash Flow to Equity here
We note that the excess cash generated by the company (CFO+CFI) can be approximated as Free Cash Flow to the Firm. We also note that EPS may not be the best measure to gauge company’s performance as it is susceptible to accounting gimmicks by the management. A better way to measure company’s performance by Investment banks and investors is to calculate Free Cash Flow to firm (FCFF) as it looks at company’s ability to survive and grow without external sources of funding (equity or debt). Discounting all future Free Cash Flow to firm provided us with the Enterprise Value of the Firm. Additionally, FCFF is widely used not only by the growth investors (looking for capital gain) but also by income investors (looking for regular dividends). Positive and growing FCFF signifies an excellent future earning capabilities, however, negative and stagnant FCFF may be a cause of worry for the business.
If you learned something new or enjoyed this free cahs flow to firm post, please leave a comment below. Let me know what you think. Many thanks and take care.
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worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu qualification – cleared all 3 CFA exams, FRM Charterholder, IIT Delhi, IIML; This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs, M&As, Private Equity, Startups, Valuations and Entrepreneurship.
When you started calculating using EBIT … Why you used “+” instead of “-” … for Changes in Working capital ? should not you better subtract it rather than add it , so the equation become : FCFF = [EBIT x (1-tax rate)] + DEP – FCInv – WCInv ……… ?Reply
Hi Ibrahim, thanks for your question. Looks like there is common confusion here regarding the changes in WC. I have added the “changes in working capital”. Reason is that I calculate the changes in working capital that take care of the “Cash inflows” or “cash outflows” directly (instead of formula). For eg. If Working capital 2016 = $150 million and Working Capital of 2015 is $100. What does this mean.. absolute changes will be ($150 million – $100 million) = $50 million. However, since this is an increase in working capital, it is a “cash outflow”. Hence, while taking this in FCFF formula, I directly use this number as -50 million (cash outflow). Hope you understood this now.Reply
Thank you for this educational tutorial Dheeraj.
Kind regards from MongoliaReply
Thanks for comprehensively providing the explanation on FCFF. Below is the doubt on which I need some more clarification.
Suppose I want to calculate current FCFF, so how do I take tenure into consideration for calculating say coming 4th quarter 2016 (FCFF of company on DEC 2016 through which I would get to know whether company is under valued or overvalued).
It would to great full if you can shed some light.
Hi Dharam, are you doing a quarterly forecast of FCFF ?Reply
Thanks for providing the nuts & bolts of FCFF. I have some questions regarding this topic as follows :-
1) Can we get all non cash items like, restructuring exp/gains, gain/loss from the footnotes of annual reports..?
2) Should we take all these non-cash items same as it was last year when we forecast the financial statements for five/seven years OR we can forecast these also..?
Please revert to me towards my queries.
Thanks once again.Reply
Hi Shalin, your answers –
1) yes, you will get all the restructuring exp/gains and losses in the annual report.
2) these non cash items are very difficult to project and hence, we typically take these as 0 (instead of taking it as constant like last year etc)
In case a company continuously has negative free cash flows for the past 3-5 years, how can we use the the same while calculating fair price of the stock by DCF model?Reply
FCFF negative in the past is not the problem.It is the future FCFF that creates issues. If the forecast for the next 5-10 years results in negative FCFF then DCF becomes redundant. In that case it is much better to use Relative Valuations.
do check the Box IPO Valuations in which i exactly the same situation.
It was really a very nice effort from your side and was a very resourceful article and I am really glad to find this site .
Also, Can you please provide a valuation of any indian firm by taking data from its annual report ? I have been trying to value WABCO India which is an auto ancillaries Company but i am not satisfied with the valuation.It will be really helpful to me if you could provide the insight taking the firm as an example.Reply
At this stage i have not picked up an Indian company example for valuation due to lack of data available. However, i will keep this in mind if i do so in the near future.
Hello Dheeraj, can you please explain me why in FCFF formula the changes in working capital are calculated as current year 2008 minus previous one – 2007, but in the FCFE formula is the other way around based on the 2 examples you showed.
Thx in advance.Reply
Hi George, can you please refer to the answer above (for Ibrahim’s question). I guess that will solve your concerns.Reply
Dear Mr. Dheeraj, good day!
Thank You for accessible explanation. It is truly invaluable! Only a professional can are available to analyze the information for understanding. I am a power engineer and then with the help of You very quickly begin to delve into the details. Thank you so much!Reply
thanks Vlad for the appreciation. I am glad you found this useful.
so clear and useful.
Dheeraj your article was well explaining but when I put all these formulas in the real world companies financial data, all the above mentioned formula gives me different answers. Can you please help me in this respect. I can share my workings along with the financials of a company which I am currently analyzing with you. Looking forward for your response.
Sure. You can share with me the financial data, hope it is not confidential.
Thank you very much Dheeraj. I have emailed you my workings along with audited accounts of a company and don’t worry as they are not confidential.Reply
Amazing Dheeraj sir.
You have cleared my all doubts related to FCFF.
But what about FCFE. Pls explain that also
Hi Akanksha, please refer to this article FCFEReply
In the FCFF starting with Net Income, why have you added back post tax Interest? Isn’t Interest an expnse that the firm won’t retain? Then how can it be a part of the Free CF?Reply
Hi Sipika, if you try to solve this – EBIT x (1-tax) = (EBT + Interest) x (1-tax) = EBTx(1-tax) + Interest x (1-tax) = Net Income + Interest x (1-tax).
Hope it is clear now.
Liked the simplicity. Thanks!Reply
Thank you dheeraj. now i understand how FCFF is used for valuation. thank you so much dheeraj……………………………………Reply
That is an elegant and superb explanation, please keep contributing the same.Reply
Thank you sir. You illustrated FCFF with accurate briefings and examples!Reply
Thanks Pratik. I am glad you liked it. 🙂Reply
thank you dheeraj but I have question that after FCFF how I can calculate residual value and the net PV after discount rate , actually I cant deal with this number I need help.
I ll appreciate that if you send templates to understand it very wellReply
wanted to know the reason for not including escrow receivables in change in working capital to calculate FCFFReply
Hi Anshuman, it could be because of certain restriction posed on escrow receivables. It could be based on certain underlying stocks that are restricted in nature.Reply
Would appreciate your help as I am doing a real case and standing a negotiation very soon for the same.
While doing DCF starting EBIDTA, is this approach correct?
– Interest Expense (net of tax)
+ Interest income on additional cash
– changes in working capital
– Tax outflow
– Any other outflows
Free cash flow to firm
Discount with appropriate WACC + calculate terminal value
– Preference shares or any other minority
Looks good to me except one. you need to add the cash and cash equivalents (current) in the Equity value (last step)/Reply
If FCFF < 0, how to stock valuation ???Reply
If FCFF<0, then you need to apply relative valuation methodologies to value this firm. You can look at Relative Valuations article here. Also, in Box IPO case, we saw that FCFF<0, hence, we applied relative valuation techniques.Reply
please help me and tell me why do we not consider cash and notes payable during fcff and 1 morething u hv mentioned that gains and losses are deducted and added back resp. ..but yReply
1. We do not adjust for cash as we take care of this in the final EV formula = Equity value + debt – cash
2. likewise, we do not adjust for notes (debt) for the same reason above.
3. Gains and losses are deducted and added back as these are non cash expenses and remember we are calculating free “cash flows”Reply
How about if the company is in the growth stage of life cycle? Their net income are positive or even growth years by years but the FCFF is negative because they need more money to expand the business and they have to borrow from the bank? In this case should we invest in this company?Reply
In such cases with negative FCFF, it is difficult to value the company on the basis of Discounted Cash flows. In such cases, you will have to look at other valuation methods like Relative Valuations etc for valuing growth companies. You may look at this example where i valued Box Inc (which had negative FCFF)Reply
Dheeraj please help me on bonds valuation fundamentalReply
Hi Vaibhav, please refer to this article – Bond PricingReply
Thank you for your reply. I wanna ask one question: are the longterm financial investments or investments in affiliate company considered as capital expenditure? Do they exist in FCFF formular?
The primary reason for using FCFF is to find the overall valuation of the company. Discounting this FCFF provides us with the Enterprise value of the firm. FCFF formula generally does consider long term financial investments in the formula. We adjust for such figures after we have arrived at the Enterprise Value. For example, Minority Interest, Investment in affiliates etc.. all of these are adjusted from the Enterprise Value (found using FCFF).
Do you have the FCFF calculation from real company? I’ve looked at financial statements from real company and there are a lot of items confused me. I have no idea that should I put those items in the FCFF formula or not.
hi dheeraj, good to see this clear presentation, i came across FCF many time but today exactly learnt and understand how it arrives and how can it links to business valuation. Tnx…Reply
Thanks Rakesh 🙂Reply
Thank you for making this educational blog. I really like the way you elaborate complex financial concept and make it easy to understand. I find your presentation very insightful and provides clarity for many complex financial concepts that I find challenging throughout my study back in university.
Keep up the good work and keep inspiring people!
Thank you again.
thanks Surya 🙂Reply
Very simple & easy to understand. Can you write about BONDS this simple.-ytm,call,put option prices, valuation,etc.?Reply
Hi Lalitha, please refer to such articles at https://www.wallstreetmojo.com/category/fixed-income/Reply
One of the best article i have ever read!!!!
Waiting for more
Can u pls tell me while calculating FCFF from Net Income why we dont adjust D&A with tax rate as we had adjusted the interest expense.Reply
Have you ever thought to write complete valuation books or financial modeling books? You will be a very good finance writer:)Reply
Thanks Vincent for the encouragement 🙂 . Unfortunately, no such current plans at this stage for books. Let’s see in the near future if I can pull out one!Reply
I will buy the first book – first edition .Reply
Gratitude for sharing.
That was quite useful and i really appreciate that.
thanks for sharing.
that was quite useful and i really appreciate that.Reply
Very detailed and explained with the use of real-time examples. Thank you very much for this article.Reply
Thanks Dhiraj.Simple. Lucid.Eay to learn.Reply
Thank you very much, it was very fruitful information. Like to post more like this.
Thanks for yor valuables and essence of learning.Reply
Thanks Dhiraj, It is very valuable for learning to all.Reply
Thank you Dheeraj, great materials! I like the way you simplified all of these important concepts (this one and other stuff here) and made it trouble-free to digest….
Kudos for your work!
#waiting for more
Very useful stuff explained in simple step. Do you take one to one consultancy.Reply
Very well written. I liked the Alibaba and Box IPO example. Do your provide consultancy to firms?Reply
Thank you Dheeraj. This is one of the most comprehensive resource on FCFF. I liked the overall presentation of this difficult concept.Reply
Thank you Viral. I am glad you liked this article.
why you collect the change in the wc ? i found many other formulas in which the writers take out the change?
thanks in advance.Reply
Hi Bulgaria, can you please have a look this answer above (question asked by Ibrahim).Reply
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What is Free Cash Flow for the Firm (FCFF)
Free cash flow for the firm (FCFF) represents the amount of cash flow from operations available for distribution after depreciation expenses, taxes, working capital, and investments are paid. FCFF is essentially a measurement of a company’s profitability after all expenses and reinvestments. It’s one of the many benchmarks used to compare and analyze financial health.
BREAKING DOWN Free Cash Flow for the Firm (FCFF)
FCFF represents the cash available to investors after a company pays all its business costs, invests in current assets (e.g., inventory), and invests in long-term assets (e.g. equipment). FCFF includes bondholders and stockholders when considering the money left over for investors.
The FCFF calculation is a good representation of a company’s operations and its performance. FCFF considers all cash inflows in the form of revenues, all cash outflows in the form of ordinary expenses, and all reinvested cash to grow the business. The money left over after conducting all these operations represents a company’s FCFF.
The calculation for FCFF can take many forms, and it’s important to understand each version. The most common equation is shown as:
FCFF = net income + non-cash charges + interest x (1 – tax rate) – long-term investments – investments in working capital
Other equations include:
FCFF = cash flow from operations + interest expense x ( 1 – tax rate ) – capital expenditures (CAPEX)
FCFF = earnings before interest and taxes (EBIT) x (1 – tax rate) + depreciation – long-term investments – investments in working capital
FCFF = earnings before interest, tax, depreciation and amortization (EBITDA) x (1 – tax rate) + depreciation x tax rate – long-term investments – investments in working capital
Benefits of Using FCFF
Free cash flow is arguably the most important financial indicator of a company’s stock value. The value/price of a stock is considered to be the summation of the company’s expected future cash flows. However, stocks are not always accurately priced. Understanding a company’s FCFF allows investors to test whether a stock is fairly valued. FCFF also represents a company’s ability to pay dividends, conduct share repurchases , or pay back debt holders. Any investor looking to invest in a company’s corporate bond or public equity should check its FCFF.
A positive FCFF value indicates that the firm has cash remaining after expenses. A negative value indicates that the firm has not generated enough revenue to cover its costs and investment activities. In that instance, an investor should dig deeper to assess why this is happening. It can be a result of a specific business purpose, as in high-growth tech companies that take consistent outside investments, or it could be a signal of financial issues.
Free Cash Flow To Equity – FCFE
Free Cash Flow-To-Sales
Free Cash Flow Per Share
Unlevered Free Cash Flow – UFCF
Free Cash Flow Yield
Free Cash Flow – FCF
How do I discount Free Cash Flow to the Firm (FCFF)?
How are cash flow and free cash flow different?
Valuing Firms Using Present Value of Free Cash Flows
Free Cash Flow vs EBITDA: Which Should You Analyze
Free Cash Flow Yield: The Best Fundamental Indicator
Free Cash Flow: Free, But Not Always Easy