FCFF, or Free Cash Flow to Firm, is the cash flowStatement of Cash FlowsThe Statement of Cash Flows (also referred to as the cash flow statement) is one of the three key financial statements that report the cash available to all funding providers (debt holders, preferred stockholdersPreferred SharesPreferred shares (preferred stock, preference shares) are the class of stock ownership in a corporation that has a priority claim on the company’s assets over common stock shares. The shares are more senior than common stock but are more junior relative to debt, such as bonds., common stockholders, convertible bondConvertible BondA convertible bond is a type of debt security that provides an investor with a right or an obligation to exchange the bond for a predetermined number of shares in the issuing company at certain times of a bond’s lifetime. A convertible bond is a hybrid security investors, etc.). This can also be referred to as unlevered free cash flowUnlevered Free Cash FlowUnlevered Free Cash Flow is a theoretical cash flow figure for a business, assuming the company is completely debt free with no interest expense., and it represents the surplus cash flow available to a business if it was debt-free. A common starting point for calculating it is Net Operating Profit After Tax (NOPAT),NOPATNOPAT stands for Net Operating Profit After Tax and represents a company's theoretical income from operations. which can be obtained by multiplying Earnings Before Interest and Taxes (EBIT)EBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income. EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue. by (1-Tax Rate). From that, we remove all non-cash expenses and remove the effect of CapEx and changes in Net Working Capital, as the core operations are the focus.
To arrive at the FCFF figure, a Financial AnalystDesignationsGuides to financial services designations. This section covers all the major designations in finance ranging from CPA to FMVA. These prominent designations cover careers in accounting, finance, investment banking, FP&A, treasury, IR, corporate development and skills like financial modeling, will have to undo the work that the accountantsAccountingPublic accounting firms consist of accountants whose job is serving business, individuals, governments & nonprofit by preparing financial statements, taxes have done. The objective is to get the true cash inflows and outflows of the business.
FCFF in Business Valuation
FCFF is an important part of the Two-Step DCF ModelDCF Model Training Free GuideA DCF model is a specific type of financial model used to value a business. The model is simply a forecast of a company’s unlevered free cash flow, which is an intrinsic valuationIntrinsic ValueThe intrinsic value of a business (or any investment security) is the present value of all expected future cash flows, discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own. method. The second step, where we calculate the terminal value of the business, may use the FCFF with a terminal growth rate,Terminal Growth RateThe terminal growth rate is a constant rate at which a firm’s expected free cash flows are assumed to grow at, indefinitely. This growth rate is used beyond the forecast period in a discounted cash flow (DCF) model, from the end of forecasting period until and assume that the firm’s free cash flow will continue or more commonly, we may use an exit multiple and assume the business is sold.
DCF Analysis is a valuable Business Valuation technique, as it evaluates the intrinsic value of the business by looking at the cash-generating ability of the business. Conversely, CompsComps - Comparable Trading MultiplesAnalyzing comparable trading multiples (Comps) involves analyzing companies with similar operating, financial and ownership profiles to provide a useful understanding of: operations, financials, growth rates, margin trends, capital spending, valuation multiples, DCF assumptions, and benchmarks for an IPO and Precedent TransactionsPrecedent Transaction AnalysisPrecedent transaction analysis is a method of company valuation where past M&A transactions are used to value a comparable business today. Commonly referred to as “precedents”, this method of valuation is used to value an entire business as part of a merger/acquisition commonly prepared by analysts both use a Relative Valuation approach, which is common in Private Equity,Financial Modeling In Private EquityFinancial modeling in private equity typically consists of building leveraged buyout (LBO) models to evaluate the probable return profile of acquiring a business. due to restricted access to information.
Example of How to Calculate FCFF
Below we have a quick snippet from our Business Valuation Modeling Course, which has a step-by-step guide on building a DCF Model. Part of the two-step DCF Model is to calculate the FCFF for projected years.
So, using the numbers from 2018 on the image above, we have NOPAT, which is equivalent to EBIT less the cash taxes, equal to 29,899. We add D&A, which are non-cash expenses to NOPAT, and get a total of 43,031. We then subtract any changes to CAPEX, in this case, 15,000, and get to a subtotal of 28,031. Lastly, we subtract all the changes to net working capital, in this case, 3,175, and get an FCFF value of 24,856.
3 Alternative FCFF Formulas
When a Financial AnalystFMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari is modeling a business, they might only have access to partial information from certain sources. This is particularly true in Private Equity, as private companies do not have the rigorous reporting requirements that public companies do. Here are some other equivalent formulas that can be used to calculate the FCFF.
FCFF = NI + D&A +INT(1 – TAX RATE) – CAPEX – Δ Net WC Where: NI = Net Income
D&A = Depreciation and Amortization Int = Interest Expense CAPEX = Capital Expenditures Δ Net WC = Net Change in Working capital
FCFF = CFO + INT(1-Tax Rate) – CAPEX Where: CFO = Cash Flow from Operations INT = Interest Expense CAPEX = Capital Expenditures
EBIT*(1 – Tax Rate) + D&A – Δ Net WC – CAPEX Where: EBIT = Earnings before Interest and Tax D&A = Depreciation and Amortization CAPEX = Capital Expenditures Δ Net WC = Net Change in Working capital
Unlevered vs Levered Free Cash Flow
FCFF vs FCFEFCFF vs FCFEThere are two types of Free Cash Flows: Free Cash Flow to Firm (FCFF), commonly referred to as Unlevered Free Cash Flow; and Free Cash Flow to Equity (FCFE), commonly referred to as Levered Free Cash Flow. It is important to understand the difference between FCFF vs FCFE as the discount rate and numerator of valuation or Unlevered Free Cash Flow vs Levered Free Cash Flow. The difference between the two can be traced to the fact that Free Cash Flow to Firm excludes the impact of interest payments and net increases/decreases in debt, while these items are taken into consideration for FCFE. Free Cash Flow to EquityFree Cash Flow to Equity (FCFE)Free cash flow to equity (FCFE) is the amount of cash a business generates that is available to be potentially distributed to shareholders. It is calculated as Cash from Operations less Capital Expenditures. This guide will provide a detailed explanation of why it’s important and how to calculate it and several is also a popular way to assess the performance of a business and its cash-generating ability exclusively for equity investors. It is especially used in Leveraged Buyout (LBO) models.
Video Explanation of Cash Flow
Watch this short video to quickly understand the different types of cash flow commonly seen in financial analysis, including Earnings Before Interest, Tax, Depreciation & Amortization (EBITDA), Cash Flow (CF), Free Cash Flow (FCF), Free Cash Flow to the Firm (FCFF), and Free Cash Flow to Equity (FCFE).
Additional Resources
Thank you for reading this guide to Free Cash Flow to Firm. CFI has an industry-specific course that walks you through how to build a DCF valuation model for Mining. The Mining Financial Model & Valuation Course is an elective for the FMVA Certificate™FMVA® CertificationJoin 350,600+ students who work for companies like Amazon, J.P. Morgan, and Ferrari . Here are some other CFI resources:
EBITDAEBITDAEBITDA or Earnings Before Interest, Tax, Depreciation, Amortization is a company's profits before any of these net deductions are made. EBITDA focuses on the operating decisions of a business because it looks at the business’ profitability from core operations before the impact of capital structure. Formula, examples
EBITEBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income. EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue.
CAPMCapital Asset Pricing Model (CAPM)The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between expected return and risk of a security. CAPM formula shows the return of a security is equal to the risk-free return plus a risk premium, based on the beta of that security
Unlevered BetaUnlevered Beta / Asset BetaUnlevered Beta (Asset Beta) is the volatility of returns for a business, without considering its financial leverage. It only takes into account its assets. It compares the risk of an unlevered company to the risk of the market. It is calculated by taking equity beta and dividing it by 1 plus tax adjusted debt to equity
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