What is 'Free Cash Flow For The Firm - FCFF'
Free cash flow for the firm (FCFF) is a measure of financial performance that expresses the net amount of cash that is generated for a firm after expenses, taxes and changes in net working capital and investments are deducted. FCFF is essentially a measurement of a company's profitability after all expenses and reinvestments. It's one of the many benchmarks used to compare and analyze financial health.
BREAKING DOWN 'Free Cash Flow For The Firm - FCFF'
FCFF represents the cash available to investors after a company has paid all of its costs of doing business, invests in current assets (such as inventory) and invests in long-term assets (such as equipment). FCFF includes both bondholders and stockholders when considering the money left over for investors.
The FCFF calculation is a good representation of a company's operations and its performance. FCFF takes into account all cash inflows in the form of revenues, all cash outflows in the form of ordinary expenses and all reinvested cash needed to keep the business growing. The money left over after conducting all of these operations represents a company's FCFF.
The calculation for FCFF can take many forms, and it's important to understand each version. The most common equation is shown as:
Other equations include:
FCFF = earnings before interest, tax, depreciation and amortization x (1 - tax rate) + depreciation x tax rate - long-term investments - investments in working capital
Benefits of Using FCFF
Free cash flow is arguably the most important financial indicator of the value of a company's stock. The value, and therefore the price, of a stock is considered to be the summation of the company's expected future cash flows. However, stocks are not always accurately priced. Understanding a company's FCFF allows investors to test whether a stock is fairly valued. FCFF also represents a company's ability to pay out dividends, conduct share repurchases or pay back debt holders. Any investor who is looking to invest in a company's corporate bond or public equity should check its FCFF.
A positive FCFF value would indicate that the firm has cash left after expenses. A negative value indicates that the firm has not generated enough revenue to cover its costs and investment activities. In that instance, an investor should dig deeper to assess why this is happening. It can be a conscious decision, as in high-growth tech companies that take consistent outside investments, or it could be a signal of financial issues.