In words, what’s the difference between the two? FCF is how much money you have left over after NI and all your expenses have been paid plus all your allocations to new capital projects have been made. RI is your net income minus your capital charges. They seem similar, can anyone help.
NI - does not include things like NWC and FCINV so it’s kind of incomplete and full of estimates as a measure for valuation. so we can turn out FCF by adding back depreciation to take out the effects of depreciation by adding back and all our need to fund the operations of the company (NWC and FCINV) once we have done this we arrive at FCFF is all capital available to EQUITY AND CREDITORS… if you are interested in all capital to equity holders then use FCFE… RI is like you said net income minus capital charges… is a measure of how much you are returning to those that provide the equity capital to you… i.e. is the company actually profitable if you have positive net income??? well…you use RI to reduce the amount that equity holder would want for their investment…
so FCF kind of describes your cash flow situation after NI has been adjusted. RI tells you if, after accounting for required return to equity, if NI was high enough to cover the required return and if you actually made a profit.
I agree with your RI summary, but not FCF. FCF really IS your cash flow situation… it doesn’t ‘describe it’. It’s the cash reality. RI stays much closer to accrual accounting but looks to add a capital charge for equity as well as the charge for debt… which is interest expense.
RI = NI - Equity*cost of equity FCFF=NI+dep-NWCinv-PPEinv+interest*(1-t) FCFE=NI+dep-NWCinv-PPEinv+net borrowing Do they really seem similar. Just remember the above formulas.
correct… you can you FCF or RI… just remember: - Use FCF if you have a control perspective… FCFF (in the case of unstable capital structure or negative FCFE), - Use RI when FCF is negative, with the caveat that clean surplus must hold
Although fun thing about clean surplus, you can use comprehensive income rather than net income to get around the issue.
yes I remember that EOC question quite clearly…
Try this to help conceptualise it: - FCF is actual cash (concrete). It’s real. Companies base their cash needs on FCF forecasts. - RI is kind of a “concept” (abstract): what the company returns to equity holders (ROE) minus what these equity holders require (Required return on equity). You apply the difference between these 2 rates to the book value of equity. It’s theoretical.