Understanding Free Cash Flow to the Firm (FCFF)
Free Cash Flow to the Firm (FCFF) represents the amount of cash flows from operations that are available for distribution after accounting for depreciation expenses, taxes, working capital, and investments. FCFF measures a company’s profitability after all expenses and reinvestments, serving as a critical benchmark to evaluate financial health.
Key Takeaways
- Free Cash Flow to the Firm (FCFF) represents the cash flow from operations available for distribution after expenses.
- Free cash flow is arguably the most important financial indicator of a company’s stock value.
- A positive FCFF value indicates available cash post-expenses.
- A negative FCFF value shows shortfall, signaling potential financial issues or strategic investments.
In-Depth Understanding of FCFF
FCFF is available for investors after a company pays all business costs, invests in current assets (e.g., inventory), and invests in long-term assets (e.g., equipment). FCFF calculation considers all cash inflows like revenues, all cash outflows like ordinary expenses, and all reinvested cash.
FCFF indicates a company’s operational performance and represents its capability to pay dividends, repurchase shares, or re-pay debt holders.
FCFF Calculation
Common ways to calculate FCFF include:
FCFF = NI + NC + (I * (1-TR)) - LI - IWC
where:
NI = Net Income
NC = Non-cash Charges
I = Interest
TR = Tax Rate
LI = Long-term Investments
IWC = Investments in Working Capital
Other variations for calculating FCFF include:
FCFF = CFO + (IE * (1-TR)) - CAPEX
where:
CFO = Cash Flow from Operations
IE = Interest Expense
CAPEX = Capital Expenditures
FCFF = (EBIT * (1-TR) ) + D - LI - IWC
where:
EBIT = Earnings Before Interest and Taxes
D = Depreciation
Additional formulation:
FCFF = (EBITDA * (1-TR)) + (D * TR) - LI - IWC
where:
EBITDA = Earnings Before Interest, Taxes, Depreciation, and Amortization
Real World Example of FCFF
Let’s examine Exxon’s cash flow statement. As of 2018:
- $8.519 billion in operating cash flow
- $3.349 billion in capital expenditures (CAPEX)
- $300 million in interest at 30% tax rate
So, FCFF can be calculated using:
FCFF = CFO + (IE * (1-TR)) - CAPEX
Plugging values in:
FCFF = $8,519 million + ($300 million * (1 - 0.30)) - $3,349 million = $5.38 billion
Cash Flow vs. FCFF
Cash flow generally represents net cash changes into and out of a company, indicating overall financial liquidity. It consists of operating, investing, and financing activities sections in the cash flow statement. FCFF, however, specifically deducts necessary capital investments and other expenditures, providing a clearer picture of a firm’s residual cash after vital investments.
Special Considerations
Although FCFF is an invaluable tool; investors should be cautious of companies manipulating figures through under-reported CAPEX or stretched payment terms. It’s vital to analyze investments deeply and time remaining FCFF trends to ensure they’re genuine and sustainable.
By thoroughly understanding FCFF, you can gain deeper insights into a company’s financial health and make better-informed investment decisions.
Related Terms: cash flow, net income, depreciation, capital expenditure, working capital.
References
- Securities Exchange Commissions. “Form 10-Q, March 31, 2018-Exxon Mobile Corporation”, Page 6.
