Funds from operations (FFO) is an alternative metric to net income. Both are used to measure the returns being generated by business operations based on income statement items. While net income measures accounting profits, FFO is a cash flow measure. FFO is calculated by adding non-cash charges, such as depreciation or amortization, to net income. Non-operating income and expenses such as interest, gains on the sale of property and minority interest are also often eliminated to get FFO from net income.
FFO is employed in evaluating businesses for which net income may not be an accurate representation of a company's operation in a normal period. Real estate investment trusts (REITs) are frequently evaluated using FFO rather than earnings per share (EPS) because depreciation expenses associated with real investment property are not typically considered a cost of operating such a business. Analysts and managers of REITs commonly employ adjusted FFO. The adjusted version generally subtracts depreciation related to classes of capitalized property that are considered elements of REIT operation rather than investment property. Furniture or carpeting are examples of property that motivate the use of adjusted FFO.
Consider the first quarter 2015 earnings release for Simon Property Group. The company reported net income for the quarter of $362 million and EPS of $1.16. FFO per share for the same period was $2.28. To calculate FFO from net income, the company added back $284 million of depreciation expense from consolidated entities and $124 million in depreciation from unconsolidated entities, and Simon subtracted nearly $3 million worth of non-controlling interest and preferred dividends.