Free Cash Flow to the Firm – FCFF | Explained

What is FCFF?

Free Cash Flow to the Firm or FCFF is
the cash flow i.e. available to all the stakeholders of the business i.e Equity
shareholders, Debt holders, Preference shareholder, Convertible bondholders,
Stock option holder, etc.  It is used to
determine the Enterprise Value (EV) of the firm.

FCFF is the actual cash flow left
after paying off all the business expenses and accounting for depreciation
expenses, taxes, working capital changes and investments.

A positive free cash flow means a
company has a sound financial health as compared to its peers. Such companies
are considered cash rich companies. While a negative FCFF indicates, the
company is not able to generate enough revenue to cover up its expenses and
investment activities

Calculations:

There are three ways to calculate FCFF
depending upon the type of entity, if it’s a listed entity, than it is easy to
get the data from its financial statements and thus formula
no. 1 is the first choice, however if it’s a private company, we don’t
have enough information about its financial and thus we could use the remaining
formula to calculate the FCFF of the company

1) FCFF = NOPAT + D&A – CapEx – Δ Net WC

NOPAT : Net operating profit after taxes = EBIT (1-
tax)

D&A : Depreciation and amortization expense (Since
this are non cash expenses, we add them back) 

CapEx : Capital Expenditure (We can find this in the
Cash flow statement under the head “ Cash flow from investing)

Δ Net WC : Changes in Net working capital = Current year
Working capital – Previous Year Working capital

2) FCFF = CFO + Interest (1 – Tax) – CapEx

CFO : Cash flow from operation

3) FCFF = NI + Interest (1-Tax) + D&A – CapEx – Δ Net WC

NI : Net Income

Example:
Infosys Limited

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