I understand the point of FCFE and FCFF and the difference between them
I also understand the point and difference between CFO and CFI and CFF.
We can use CFO to calculate FCFE and FCFF…but then where do CFI and CFF come into play for FCFE? CFI would be involved in the FCinv portion, but surely that doesn’t capture all the CFI cash flows? Same for CFF…that would be accounted for with net borrowings for FCFE. But then there’s all the GAAP vs IFRS differences for which cash flow certain items are classified under, yet for FCFE and FCFF we don’t have to consider this at all?
I’m ok with calculating the free cash flows (and I need a bit of a refresher for CFO, CFI, and CFF from level I) but I don’t really understand the relationship between them. Anyone have any insight that can help me?
FCFF and FCFE can be completely calculated through the cash flow statements.
For FCFE and FCFF, you need to get the FCF first by taking the net cashflows from operating activity, and netting all fixed capital investments, then you remove the effects of interest for FCFF, and adjust for net borrowings for FCFE.
That’s all there is to it. Dividends if included in CFO needs to be removed as it is a subordinate claim. And interest needs to be removed for FCFF from the CFF if it’s included there as well.
It’s just a matter of reconciling the cash flow items for things like interest and dividends where they differ depending the company’s reporting.
Ok I think I’ve refined my question a little more. I’m having trouble explaining why I’m confused…all I know is that I don’t truly understand the relationship yet.
FCFE is the free cash flow that’s available to equity holders. All the net cash flow should be available to equity holders, shouldn’t it? So shouldn’t FCFE = CFO + CFI + CFF?
In a way, yes. Except for dividends since they are part of the FCFE, so you don’t remove them. FCFE is the cashflow available for distribution to all shareholers, after all obligations and claims have been met.
The difference is, FCFE in valuation uses pro forma financial statements to make forecasts. So non-recurring, or non-operating items on the cash flow statement may not be included in projections where their effects are very difficult to estimate. Hence why we only use all of the CFO, CapEX (CFI), and net debt borrowing (CFF) since their cashflow is easily estimated based on past performance, management guidance, and top-down analysis. This should give you more or less the average amount of FCFE over all the coming years, give or take one-time items.
But as with any analysis, due dillegence is nessecary, and the company might report recurring losses on the CFF, so you need to adjust accordingly, but we are assuming a normal case study in general.
Not only dividends, but also CFF from transactions involving stock. It would be silly to sell a bunch of stock, then say that the resulting cash flow belongs to the shareholders; if you were going to give it back to them, you wouldn’t have sold the stock in the first place. Thus, the only contribution to FCFE from CFF is net _ borrowing _.
FCFE = CFO + CFI + CFF + dividends - issued stock …? Unless there are other components of CFF aside from net borrowing and stock sold. I wonder how stock compensation gets involved in all this?
Anyway, I’m understanding now why we would use FCFE. It doesn’t always have to be used using pro forma reporting though, right?