Depreciation in FCF calculation
Hello. This might be somewhat a confusing question but I hope someone can explain it to me better than my prof haha
So for free cash flow, one of the formulas is FCF = NOPAT - △NWC + Depreciation - △Capex
And Capex is generally △Capex = △PP&E + Depreciation.
So what's the point of adding back depreciation in the initial FCF formula if its substracted afterwards (as apart of △Capex)?
I'm kinda having a hard time understanding the two depreciations in the process above, more specifically depreciation in Capex.
Typically change in capex is just the pp&e bought or sold during the time period in question. Don’t double count it.
I would recommend viewing capex as its own item, as opposed to something you can derive from the change in PP&E. It makes it more confusing than needed.
However, this should help:
Net PP&E is downwardly adjusted from one period to another due to depreciation. This "adding back" of depreciation that you note is not adding to FCF, it's simply negating the downward reduction to the net PP&E accounts. Therefore, you aren't double counting when you separately add back depreciation in computing FCF.
Let me know if that doesn't make sense.
^ This.
1) Someone can correct me, but I don't believe there are 'two depreciations'. That would be a double count
2) Seems your confusion is 'why add back depreciation since it [FCF] accounts for capital spending?'. FCF measures capital spent at this point in time and not what happened in the past. Also, don't forget that depreciation is a non-cash operating expense and capex is a cash investing expense.
3) Capex = change in gross PPE = change in net PPE + change in accumulated depreciation. If you are trying to calculate FCF, you can just use the change in net PPE and not add back depreciation
Thanks for your replies! That clears up my confusion with depreciation in Capex.
In that case, would you suggest omitting the adding back of depreciation in Capex when calculating FCF? Because some textbooks do not and some do. For instance, Apple's financial statements on Yahoo Finance takes Capex to be exactly the same as the Netpurchase of PP&E, without considering depreciation.
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