im currently doing the Elanguides questions and I’m having a problem with the FCFE. when calculating the CFO, i take the Net income and add depcreciation back to it. but for some reason, i have to also subtract working Capital investment as well to get the CFO. Can someone please explain why this is done?
FCFE= CFO- fixed capital investment+ net borrowing.
Think how CFO is calculated using the indirect method:
CFO = NI + Depreciation + Positive change in current liabilities - Positive change in current assets
= NI + dep - (Change in current assets - Change in current liabilities)
= NI + Dep - Change in working capital.
We won’t have to derive this. I’m sure I’ve seen the formulas for calculating FCFE and FCFF somewhere, but cant recall which reading.
Thank you. it makes sense know.
now* . 8 hours studying today, my brain is dead haha.
Dear Khaykin,
As per formula for CFO, we need to add net income, non cash expenses and cash flow which is occured but not mentioned in income statement. As we know working capital is not an expense, it is nowhere shown in the income statement. Hence, any additional requirement of working capital, which is a cash outflow to the firm, is subtracted for calculation of CFO.
If working capital is getting reduced, i.e. difference between the working capital of current year and previous year is negative then difference amount’s absolute value shall be added.
Kailas Kale