How it works
There are two versions. Free cash flow to the firm (FCFF) is available to all providers of capital and is used in a DCF with WACC. Free cash flow to equity (FCFE) is what is left for shareholders after debt payments.
Free cash flow is more informative than profit, because it shows actual cash. Profit can look healthy while cash is tied up in inventory or unpaid invoices.
FCFF = EBIT × (1 − tax rate) + Depreciation and amortisation − Capital expenditure − Increase in working capital
FCFE = FCFF − Interest × (1 − tax rate) + Net borrowing
A simple example
How it is used
- The cash flows in a DCF valuation.
- Judging whether dividends and debt payments are affordable.
- Spotting profit that is not turning into cash.
Common mistakes
- Forgetting the increase in working capital.
- Using accounting profit instead of cash.
- Treating growth spending as if it were maintenance spending.
- Using FCFF with the cost of equity, or FCFE with WACC.
Questions
What is the difference between FCFF and FCFE?
FCFF is the cash available to lenders and shareholders together. FCFE is what is left for shareholders after paying lenders. FCFF is discounted at WACC. FCFE is discounted at the cost of equity.
Is free cash flow the same as operating cash flow?
No. Operating cash flow is before capital expenditure. Free cash flow subtracts capital expenditure.
Keep learning
- What is a DCF (discounted cash flow)?
- What is EBITDA?
- What is WACC (weighted average cost of capital)?
- Guide: Financial modeling
- Free 3-statement model template
- Damodaran: working capital by sector
- Glossary: Free cash flow (FCF)
- Glossary: Working capital
- Glossary: Capital expenditure (capex)
- Glossary: Cash flow statement