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Difference Between FCFF and FCFE

business and financeFCFF vs FCFE

FCF is an acronym in corporate finance referring to the term ‘Free Cash Flow’. Free Cash Flow is the cash flow available to be distributed amongst the organization’s security holders. These are the debt holders, equity holders, convertible security holders, and preferred holders.

Free Cash Flow is calculated as follows: Net income + depreciation (both obtained from the current income statement) less working capital changes and capital expenditure (obtained from current or prior balance sheets). The standard Statement of Cash Flows will include the net income, depreciation or amortization, and the changes in working capital.

There are two notable differences between Free Cash Flow and Net Income. The first deals with accounting for the usage of capital goods. With the Net Income measure, depreciation is used, whereas with the measure of Free Cash Flow, the previous period’s ‘net capital buys’ is used. The other notable difference is that while the Free Cash Flow measure subtracts increases in net working capital, the Net Income does not.

Net Free Cash Flow also permits for cash available to clear the company’s short-term debt. Likewise, it should be able to cater for any dividends that the company intends to pay out.

Thus, Net Free Cash Flow can be calculated as follows: Net Free Cash Flow = operation cash flow ‘“ capital expenses to maintain current operation level – dividends ‘“ current long-term debt ‘“ depreciation. The definition of Capex includes any added investment on new equipment. Dividends refer to the proceeds that the company intends to pay out to its share holders. In order not to create defaults, the company has to pay a minimum debt amount referred to as the Current Portion of LTD.

In investment banking, Free Cash Flow is defined using the formula: Net Income + Non-cash charges ‘“ working capital expenditures ‘“ capex ‘“ working capital expenditures = Free Cash Flow to the Firm (FCFF).
Free Cash Flows to the Equity (FCFE) = Net income + Non-cash charges ‘“ capex ‘“working capital expenditures + Net borrowing ‘“ Net debt repayment.

Simply represented, FCFE = FCFF + Net borrowing ‘“ Net debt repayment.
FCFF and FCFE determine the ease with which a business can grow, and issue dividends to shareholders.

Summary:
FCFF is Free Cash Flow to the firm, and FCFE is Free Cash Flow to the Equity.
FCFF is a ‘sub-set’ of FCFE as in: FCFE = FCFF + Net borrowing ‘“ Net debt repayment.
FCFF = Net Income + Noncash charges ‘“ working capital expenditures ‘“ capex ‘“ working capital expenditures.
FCFE = Net income + Non-cash charges ‘“ capex ‘“working capital expenditures + Net borrowing ‘“ Net debt repayment.


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