What Is Free Cash Flow?

• After accounting for non-cash expenses, changes in operating assets and

liabilities, and capital expenditures, free cash flow is the quantum of cash
flow generated (net of taxes) by a company.
• Simply put, free cash flow refers to the funds that remain after all
payments, investments, and other obligations have been met. The monies
left over for distribution among stockholders, bondholders, and investors
are referred to as free cash flow.
• Because they exclude substantial capital expenditures and changes in
cash owing to changes in operating assets and liabilities, Free Cash Flow is
a more accurate indicator than EBITDA, EBIT, and Net Income. Non-cash
expenses are also included in measurements like EBIT and Net Income,
which further distorts the view of the underlying cash flow of a company.
FCFF
• Free cash flow refers to the cash available to investors after
paying for operating and investing expenditures.
• FCFF is usually computed by adjusting operating EBIT for non-
cash expenses and fixed and working capital investments.
• FCFF= Operating EBIT- Taxes + Depreciation/Amortization
(non-cash expenses)- fixed capital expenditure-Increase in net
working capital
• FCFF = Net Income + Interest expense adjusted for tax + non-
cash expenses – Fixed capital expenditures – Increase in net
working capital
FCFE
• FCFE= Net Income + Interest expense adjusted for tax + Non-
cash expense – fixed capital expenditure-Increase in net
working capital
• FCFE=Operating EBIT- Interest- Taxes+
Depreciation/Amortization (non-cash cost)– fixed capital
expenditure-Increase in networking capital-net debt repayment
• FCFE = Operating EBIT – Interest – Tax + Depreciation or
Amortization (non-cash expenses) – Fixed capital expenditures
– Increase in networking capital – Net debt repayment
• Alternatively, FCFE = Cash flow from operations – Fixed capital
expenditures – Net debt repayments + New debt
 Key Differences Between FCFF vs FCFE
• In the firm, FCFF is the amount that remains for all investors, including
bondholders and stockholders, while FCFE is the residual amount that remains for
common equity holders.
• FCFF excludes the impact of leverage since it does not consider the financial
obligations while arriving at the residual cash flow, known as unlevered cash flow.
FCFE includes the impact of leverage by subtracting net financial obligations.
Hence it is referred to as levered cash flow
• In DCF valuation, they use FCFF to calculate the enterprise value or the total
intrinsic value of the firm. FCFE is used in DCF valuation to compute equity
value or the intrinsic value of a firm available to common equity shareholders
• When performing DCF valuation, they pair FCFF with a weighted average cost of
capital to consistently incorporate all the capital suppliers for enterprise
valuation. They consistently pair FCFE with the cost of equity to incorporate the
claim of only the common equity shareholders.