What's the difference between free cash flow to equity and accounting profits?

The key difference between free cash flow to equity (FCFE) and accounting profit is while the former calculates the cash available to be paid out to shareholders after paying off all debts, expenses and reinvestment, the latter is the simple accounting difference between revenue earned and total costs. In practical terms, FCFE is a measure of a company's performance from a shareholder's perspective while accounting profit is a bookkeeping measure of profit excluding any implicit costs such as opportunity costs.

How Free Cash Flow to Equity Is Used

The purpose of FCFE is to help potential investors understand how much cash may be paid out to a company's equity shareholders as a dividend or to execute a stock buyback from shareholders. Consequently, this cash is available only to a company's shareholders. FCFE is used to analyze stock and a company's ability to pay dividends, repay debt and manage stock performance. It is also used by shareholders and analysts to determine the health of a company and estimate its value in the stock market. FCFE is used by companies to raise share prices and pass on capital gains tax benefits to their shareholders by making them eligible for lower tax rates on buybacks.

What Accounting Profit Represents

Accounting profit is a metric recorded on a company's balance sheet as required by generally accepted accounting principles (GAAP). It represents all profits, cash or otherwise, after the company has paid all its explicit costs. These explicit costs include wages, invoice payments, taxes, interest and depreciation. It is used as a gross indicator of the performance of a company on a balance sheet and is rarely used to calculate stockholder earnings. (For related reading, see "How Do Economic Profit and Accounting Profit Differ?")