I am trying to understand why certain adjustments or lack of adjustments are applied in calculating FCFF when a company uses the IFRS method. I will be copying and pasting sentences from the the Financial Reporting and Analysis book and then I wil attempt to explain my understanding of that sentence. If you could just guide/correct/direct me that would be fantastic. This post will be fairly wordy.
Thank you in advance.
“If interest paid was including in financing activity, then CFO does not have to be adjusted for Int(1 - tax rate)”. Per the book, FCFF is the cash available to company’s suppliers of debt and equity capital after all operating expenses including income have been paid and necessary investments in working capital and fixed capital have been made. Would it not make sense to add it back to CFO as it will disclose the combined FCFF available to all suppliers of Debt and Equity and also because NI is net of Interest after tax? I know it is a financing outflow and not a operating out flow but something is not clicking.
“If the company has placed interest and dividends received in investing activities, these should be added back to CFO to determine FCFF.” As mentioned earlier, FCFF is cash available to company’s supplier of debt and equity, so this would be ‘other income’ as a cash inflow to the company which is then available to be paid to the debt and equity suppliers.
“If dividends were subtracted in the operating section, these should be added back in to compute FCFF” Again, it is to show cash available to all debt and equity suppliers.
The reason that we add interest net of taxes to CFO computed under US GAAP is that it was subtracted to arrive at CFO. Under IFRS, if we treat interest net of taxes as CFF, then it was not subtracted to arrive at CFO, so we don’t need to add it back: there is nothing to correct.
If interest and dividends received were considered operating activities, they’re already in CFO, so no correction is necessary. If they were considered investing activities, then they haven been included in CFO, so we need to add them in.
If dividends paid were considered a financing cash flow. then they weren’t subtracted from CFO, so no correction is necessary. If they were considered an operating cash flow, they need to be added back in.