What is Free Cash Flow for the Firm (FCFF)

Free cash flow for the firm (FCFF) represents the amount of cash flow from operations available for distribution after depreciation expenses, taxes, working capital, and investments are paid. 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.

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Understanding Free Cash Flow

BREAKING DOWN Free Cash Flow for the Firm (FCFF)

FCFF represents the cash available to investors after a company pays all its business costs, invests in current assets (e.g., inventory), and invests in long-term assets (e.g. equipment). FCFF includes 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 considers all cash inflows in the form of revenues, all cash outflows in the form of ordinary expenses, and all reinvested cash to grow the business. The money left over after conducting all these operations represents a company's FCFF.

Calculating FCFF

The calculation for FCFF can take many forms, and it's important to understand each version. The most common equation is shown as:

FCFF = net income + non-cash charges + interest x (1 - tax rate) - long-term investments - investments in working capital

Other equations include:

FCFF = earnings before interest and taxes (EBIT) x (1 - tax rate) + depreciation - long-term investments - investments in working capital

FCFF = earnings before interest, tax, depreciation and amortization (EBITDA) 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 a company's stock value. The value/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 dividends, conduct share repurchases, or pay back debt holders. Any investor looking to invest in a company's corporate bond or public equity should check its FCFF.

A positive FCFF value indicates that the firm has cash remaining 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 result of a specific business purpose, as in high-growth tech companies that take consistent outside investments, or it could be a signal of financial issues.