![]() ![]() ![]() Since we have already deducted tax, the interest expenditure should be reduced to account for its effect. Abbreviated as OCF, Operating Cash Flow is the amount of cash generated by the operating activities of a business. Thus, we have one last adjustment to make before we can arrive at the free cash flow to the firm (FCFF) number. However, adding back the entire interest expense would also be an oversimplification. Thus we arrive at a modified formula which isįCFF = Cash flow from Operations Net Investment in Long Term Assets + Interest Expense Hence, we must add this interest expense back our above formula. All we are concerned about is that it reduces the money available for the investors. We are not concerned whether the money is spent because of regular operations or not. Well, when calculating free cash flow to the firm (FCFF) the perspective changes. Hence, we subtract them from operating cash flow and send them to financing cash flows. That is because, the operating cash flows of the firm would remain the exact same regardless of whether we ran the business on own money or on borrowed money. We consider interest expense as a financing expense. There is another complication that is introduced because of the way we treat interest expense while preparing statement of cash flows. To consider this to be the accurate derivation of free cash flow to the firm (FCFF) would be an oversimplification. Therefore, simply put, free cash flow to the firm (FCFF) can be derived from cash flow from operations in the following manner:įree Cash Flow to the Firm (FCFF) = Cash flow from Operations Net Investment in Long Term Assets We already know that the difference between free cash flow to the firm (FCFF) and cash flow from operations arises because we consider long term investments as being the part of one whereas we do not consider for the other. The Difference Is Net Cash Flow towards Long Term Investments: The conceptual understanding that we built in the previous article regarding the difference between these two closely related terms will come in handy here. These types of questions involve a complete cash flow statement being provided as the question and expect the student to derive free cash flow to the firm (FCFF) as an output. This metric is the cash flow from operations. Now, its time to move on to the second metric which can be used to derive the free cash flow to the firm (FCFF). ![]()
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