Free Cash Flow (FCF)

What is Free Cash Flow (FCF)?

Free cash flow is an accounting measure of a business’s cash flow to see what is available (hence “free”) for distribution to the securities holders of a corporate entity. It represents the cash flow after adjusting for required expenditures, such as taxes, required capital expenditures, etc.

Types of Free Cash Flow

If the type isn’t specified (eg: simply Free Cash Flow), then it usually refers to free cash flow to the firm (FCFF).

Free Cash Flow to Firm (FCFF)

This represents cash flow available to all stakeholders in the firm, which includes debt holders. This is what we typically refer to when we were to the free cash flow of a firm.

Free Cash Flow to Equity (FCFE)

This represents cash flow available to all EQUITY holders in the firm, which EXCLUDES debt holders. This is similar to FCFF except that it’s after the effect of interest payments and mandatory debt repayments; hence having taken care of debt holders, the rest goes to the equity holders.

How to Calculate Free Cash Flow

Calculating Free Cash Flow to Firm (FCFF):
Revenue Starting point
– Cost of Goods Sold
– Other Operating Expenses
= Operating Income Sometimes starts from EBIT
– Taxes Required to be paid to government
– Capital Expenditures Required to keep business running
+ Depreciation and Amortization D&A is non-cash but was included in EBIT
+ Other Non-Cash Charges If any
= Free Cash Flow to Firm (FCFF) And done!

Free Cash Flow to Equity (FCFE)

Calculating Free Cash Flow to Equity (FCFE):
Free Cash Flow to Firm (FCFF) Starting point (see above)
– Interest expense and mandatory debt payments
+ Tax shield from interest costs
= Free Cash Flow to Firm (FCFE)
Like this article? Share it so your friends can see it too!Share on FacebookShare on Google+Tweet about this on TwitterDigg thisPin on PinterestShare on Tumblr