With this FCFF calculator, you can easily calculate the free cash flow to firm (FCFF) which will help you to value a company. FCFF is one of the most commonly used cash flows when performing a discounted cash flow analysis.
This article will help you understand what is FCFF in finance and how to calculate FCFF. We will also help you understand the free cash flow to firm valuation method. But first, let's talk about the definition of FCFF.
What is FCFF in finance?
Free cash flow to firm (FCFF) is a company's cash flow left for distribution to all funding providers, usually debt and equity holders, after taking into account all the expenses and reinvestments.
As a company's assets are made up of capital contributed by its debt and equity holders, the FCFF is thus considered to be one of the best metrics to value a company. Hence, FCFF features very prominently in most company valuation techniques, including the famous discounted cash flow (DCF) analysis.
Next, let's look at how to calculate FCFF using the FCFF formula.
How to calculate FCFF? Free cash flow to firm formula
To understand the FCFF calculation, let's use Company Alpha as an example. Company Alpha reports the following information:
- Net income: $56,000,000;
- Earnings before interest, taxes and depreciation and amortisation (EBITDA): $145,000,000;
- Earnings before interest and taxes (EBIT): $95,000,000;
- Cash flow from operation (CFO): $81,000,000;
- Depreciation and amortization (D&A): $50,000,000;
- Interest expenses: $15,000,000;
- Corporate tax rate: 30%;
- Fixed capital investment: $100,000,000; and
- Working capital investment: $25,000,000.
As FCFF is a very flexible metric, we will introduce 4 ways that we can calculate it in this article:
- Calculate FCFF from net income
FCFF can be calculated using
net income, the formula is as follow:
FCFF = NI + D&A + IE * (1 - CIT) - FCI - NWC
NI- net income;
D&A- deprecation and amortization;
IE- interest expense;
CIT- corporate tax rate;
FCI- fixed capital investment; and
NWC- working capital investment.
In our example, the
FCFFfor Company Alpha is
$56,000,000 + $50,000,000 + $15,000,000 * (1 - 30%) - $100,000,000 - $25,000,000 = -$8,500,000.
- Calculate FCFF from EBIT
EBIT, which stands for earnings before interest and taxes, is also a component of
FCFF. The relationship is displayed in the formula below:
FCFF = EBIT * (1 - CIT) + D&A - FCI - NWC
Thus, Company Alpha's
$95,000,000 * (1 - 30%) + $50,000,000 - $100,000,000 - $25,000,000 = -$8,500,000.
- Calculate FCFF from EBITDA
The earnings before interest, taxes, depreciation and amortization, or
EBITDAin short, is another
FCFFcomponent. The equation to calculate
EBITDAis as follow:
FCFF = EBITDA * (1 - CIT) + D&A * CIT - FCI - NWC
FCFFin our example is
$145,000,000 * (1 - 30%) + $50,000,000 * 30% - $100,000,000 - $25,000,000 = -$8,500,000.
- Calculate FCFF from CFO
Lastly, we can also calculate FCFF from CFO, which is the cash flow from operation. We can complete this calculation using the following formula:
FCFF = CFO + IE * (1 - CIT) - FCI
For this example, FCFF can be calculated as
$81,000,000 + $15,000,000 * (1 - 30%) - $100,000,000 = -$8,500,000.
The strengths and weaknesses of free cash flow to firm valuation?
To understand what is FCFF in finance, you need to learn about its strengths and weaknesses.
Here are some strengths for FCFF:
- FCFF can be distributed to the company's owners directly
FCFF represents the amount of cash left to be distributed to the debt and equity holders of the firm. This is one of the main reasons FCFF is used in most company valuations - FCFF is one of the most relevant cash flows to debt and equity holders.
- Easy to tailor to different assumptions
As demonstrated in the examples above, FCFF can be calculated in various ways. This makes FCFF a very flexible tool for valuing a company as it can easily work with different assumptions.
However, FCFF also has some weaknesses:
- Differences in accounting standards need to be addressed
As the components of the free cash flow to firm formula are mainly based on accounting numbers, it is crucial to adjust for the differences in accounting principles used by various companies. For instance, we need to make adjustments if we are valuing companies using the IFRS standards and the US GAAP standards.
- FCFF formula is subjected to accounting manipulations
As FCFF is usually calculated from bottom-line accounting numbers such as net income, FCFF is subjected to accounting manipulations. For example, if a company adopts an aggressive accounting principle, the FCFF produced using the FCFF formula will be biased upwards.