What is Free Cash Flow to the Firm (FCFF)?
Free cash flow to the company (FCFF) is available for distribution after depreciation, taxes, working capital, and investments. FCFF measures a company’s profitability after costs and reinvestments—one of several benchmarks used to assess a company’s financial health.
Understanding FCFF to the Firm
A company’s FCFF is the cash available to investors after covering business expenditures, investing in current assets (e.g., inventory), and long-term investments (e.g., equipment). Free Cash Flow to the Firm considers bondholders and shareholders as beneficiaries of the remaining cash for investors.
FCFF measures a company’s performance and operations and analyzes cash inflows as revenues, outflows as costs, and reinvested capital for business growth. FCFF is a company’s remaining funds after these activities.
Free cash flow is perhaps the most significant financial indication of a company’s stock value. Stock prices are based on the company’s predicted future cash flows. Stock prices aren’t always correct. Investors may determine a stock’s fair value by understanding its FCFF. FCFF indicates a company’s capacity to pay dividends, repurchase shares, or repay debt holders. Before investing in a company’s corporate bond or public stock, verify its FCFF.
A positive FCFF number means the company has cash after spending. Negative values imply the business has not earned enough income to cover expenditures and investments. In the latter instance, investors should investigate why expenses and assets surpass income. High-growth tech businesses that make frequent outside investments may have a definite commercial goal or may indicate financial concerns.
Calculating Free Cash Flow to the Firm (FCFF)
The calculation for FCFF can take several forms, and it’s essential to understand each version. The most common equation is the following:
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
Free cash flow to the firm can also be calculated using other formulations. Other formulations of the above equation 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
FCFF=(EBITDA×(1−TR))+(D×TR)−LI−IWC
Where:
EBITDA=Earnings before interest, taxes, depreciation and amortization
The Difference Between Cash Flow and FCFF to the Firm
Cash flow is the net amount of cash and cash equivalents entering and leaving an organization. A corporation with positive cash flow can settle debts, reinvest, return money to shareholders, and pay costs due to increased liquid assets.
The cash flow statement has three parts that describe operations. These parts include cash flow from operating, investing, and financing operations.
FCFF refers to a company’s cash flows after deducting investment in fixed assets, depreciation charges, taxes, working capital, and interest. In other words, free cash flow is the remaining cash after a corporation pays its operational and capital expenses.
Special Considerations
FCFF offers investors significant information, but it is not perfect. Accounting deception is still possible for crafty organizations. Without a statutory framework for FCFF, investors differ on whether items are capital expenditures.
Investors should monitor corporations with high FCFF levels for underreporting capital expenditures and R&D. Depleting stocks, delaying payments, and tightening payment collection practices can also enhance FCFF. Although transitory, these efforts may reduce current liabilities and adjustments to working capital.
Conclusion
- Free cash flow to the company (FCFF) is the cash flow from operations available for distribution after depreciation, taxes, working capital, and investments.
- Free cash flow is perhaps the most important stock value indicator.
- A positive FCFF number means the company has cash after spending.
- Negative values imply that the business has not earned enough income to cover expenditures and investments.
