FMP
Oct 31, 2023 12:03 PM - Parth Sanghvi(Last modified: Jul 25, 2024 5:18 PM)
Free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) are two of the most important metrics used in financial modeling. Both metrics measure the amount of cash that is available to a company's shareholders and creditors, but there is a key difference between the two.
FCFF measures the cash flow that is available to all capital providers, including debt holders and equity holders.
FCFE, on the other hand, measures the cash flow that is available to equity holders only.
One of the most common ways to derive FCFF is by adding tax adjusted interest expense (TAIE = Interest Expense * (1 - Tax Rate) to the companies operating cash flow (OCF), then subtracting capital expenditures (capex). The formula would look something like this:
FCFF = OCF + Tax-Adjusted Interest Expense (TAIE) - Capex
FCFE is calculated by subtracting capex from operating cash flows, and then adding back debt issuance.
FCFE = OCF - Capex + Net Debt Issuance
FCFF and FCFE are important metrics for investors because they measure a company's ability to generate cash flow that can be used to pay dividends, invest in new growth opportunities, or repay debt.
FCFF is particularly important for creditors, as it is a measure of how much cash a company has available to service its debt obligations. FCFE is important for equity investors, as it is a measure of how much cash a company has available to return to its shareholders in the form of dividends or share buybacks.
FCFF and FCFE can be used in a number of ways, including:
FCFF is typically used to value companies, while FCFE is used to value equity. FCFF is also used to evaluate a company's ability to service its debt.
Let's say that a company has the following financial statements:
Income Statement | Amount |
Revenue | $100 million |
Cost of goods sold | $60 million |
Operating expenses | $20 million |
Operating Income | $20 million |
Interest Expense | -$7 million |
Income Before Tax | $13 million |
Income Tax Expense | $3 million |
Net income | $10 million |
Balance Sheet | Amount |
Cash | $20 million |
Accounts receivable | $10 million |
Inventory | $5 million |
Total assets | $35 million |
Accounts payable | $5 million |
Accrued expenses | $2 million |
Long-term debt | $10 million |
Total equity | $18 million |
Cash Flow Statement | Amount |
Operating Cash Flow | $8 million |
Financing Cash Flow | -$2 million |
Net Debt Issuance | $1.5 million |
Other Financing CF's | -$3.5 million |
Investing Cash Flow | $3 million |
Capital Expendiutures | $1 million |
To calculate FCFF we first must find the effective tax rate for the company, to do this we can use the income before tax and the Income Tax paid fields as such:
Tax Rate = Income Tax Expense / Income Before Tax
Tax Rate = 3M / 13M = 23.077% = ~23.08%
Next, we can locate OCF to be $8M, Interest Expense to be $7M, and Capex to be $1M (in addition to our tax rate above of 23.08%). Now we have the necessary innputs to calculate FCFF, which can be done like so:
FCFF = OCF + Tax-Adjusted Interest Expense (TAIE) - Capex
FCFF = $8M + (-$7M * (1 - 0.2308)) - $1M
FCFF = $8M - $5.385M - $1M
FCFF = $1.615M
Lastly, we can use these same inputs alongside Net Debt Issuance (from the cashflow statement) to caluclate FCFE:
FCFE = OCF - Capex + Net Debt Issuance
FCFE = $8M - $1M + $1.5M
FCFE = $8.5M
FCFF and FCFE are two important metrics that can be used to value companies and evaluate their financial performance. FCFF is typically used to value companies, while FCFE is used to value equity. FCFF is also used to evaluate a company's ability to service its debt.
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