Key Takeaways

• Free cash flow to firm (FCFF) is a portion of a company's cash that could be distributed without affecting its operations

• FCFF=EBIT× (1-tax rate)+Non-cash expenses-Capital Expenditure-Change in working capital

• FCFF provides important insights into the value and health of a company

Understanding FCFF

Free cash flow to firm (FCFF) refers to the amount of cash flow available to distribute without affecting its operations. FCFF also is a good indicator of a company's ability to pay dividends, conduct share repurchases, or pay back its debt.

A common equation for FCFF is the following:

FCFF=EBIT(1-tax rate)+Non-cash expenses-Capital Expenditure-Change in working capital

(EBIT stands for earnings before interest and taxes, is a company's net income before income tax expense and interest expenses are deducted.

Capital expenditures are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, or equipment.

Working capital represents the difference between a company’s current assets and current liabilities.)

FCFF is one of the many benchmarks used to compare and analyze a firm's financial health. A positive FCFF value indicates that the firm has remaining cash after expenses and investments. In contrast, if the value is negative, the firm has not generated enough cash to cover its costs and investment activities.

FCFF provides an insight into the value and the health of a company that is missing from the income statement. By taking non-cash expenses, capital expenditure, and changes in working capital into account, FCFF is more transparent in showing the company's potential to produce cash and profits compared to net income.

FCFF vs. FCFE

There are two types of Free Cash Flow: Free Cash Flow to Firm (FCFF, also referred to as Unlevered Free Cash Flow) and Free Cash Flow to Equity (FCFE, also referred to as Levered Free Cash Flow).  

The FCFF is the free cash flow available to all investors, both equity and debt holders. By further accounting for payment of interest on debt and net debt issued, the FCFE represents the free cash flow ultimately available for distribution only to equity holders.

A common equation for FCFE is the following:

FCFE=FCFF-Interest × (1-tax rate)+Net borrowing