Calculating FCF question
Which equation do you guys use and why?
FCF = net income + amort/deprec - changes in working cap - cap ex
or
FCF = cash from operating - cap ex
I know the two are theoretically equivalent. The internet has led me to believe that the first is old school, and the second is more accurate. I was instructed to use both methods. The second one seems like a clear winner, though, since it's a lot quicker to do, and more "accurate."
I learned it FCF = NI + A/D - change in working cap - capex
^ have you ever compared results of the two? i'm seeing a few million dollar discrepancy between the two for the first couple of years of a tech. company, and considering the relatively small FCF value, this discrepancy is a huge %. i'm guessing trends in the long run will still be similar...
FCF = (NI + Interest)(1-Tax Rate) + D&A - Cappex - Changes in Net Working Capital. FCF = (Revenue - CoGS - SG&A (which includes D&A))(1-Tax Rate) + D&A - Cappex - Changes in NWC
Two forms of FCF - levered and unlevered
Unlevered FCF = EBIT(1-T) + D/A - Change in Net Working Capital - CapEx Levered FCF = Same as above except use EBT instead of EBIT
Levered FCF is only available to equity holders since interest has already been paid off, while unlevered is available to both debt and equity holders. If plugging into a DCF you'll want to discount appropriately (i.e. WACC for unlevered, cost of equity for levered)
This - obviously on a recurring / underlying basis. EBIT(1-T) is also known as NOPAT or EBIAT if you come across these terms.
Accounting Question (Free Cash Flow) (Originally Posted: 11/17/2013)
Hey guys, had a quick question about calculating free cash flow. I was basically taught that unlevered free cash flow is Cash Flow from Operations less Capex. Is this correct? Also, would you include intangible additions, acquisition of new businesses, and disposal of assets to get to a "net capex" figure to use in the above FCF definition?
Thanks a lot!
There will be a difference if the company has reorganization or other non-cash items in cashflows from ops (or other complicated accounting transactions). We use both depending on the company and circumstances. Getting them to tie is a good way to think through a company's non-cash items.
You need to add back interest payments to get unlevered free cash flow. To your question, yes, adjust for asset sales to get a net capex number. Having said that, in interviews you can usually get away with saying Capex.
for the purpose of valuation, no you do not include asset sales...
Also, you are not just adding back interest payments. You would also have to account for the tax shield that you got as a result of the interest expense.
Better to start with EBIT and work down than with CFFO and work backwards if you can...
Cash flow from operations less capex is levered free cash flow, since you're starting with net income and not adding bank interest and tax shields
UFCF= EBIT(1-T) + D&A - increase in WC - capex.
That's the definition I learned.
yes that is the definition. in banking, for levered, we take CFO-capex as a proxy.
Unlevered Free Cash Flow - Interviewers Are Clueless (Originally Posted: 01/08/2015)
Had 6 ib interviews recently and twice I was asked how to calculate FCFF from various starting points (one from Net Income, other from EBITDA). Both times interviewers said I was wrong and it just pissed me off especially when you know it's not a stress test -- they genuinely thought I was wrong.
I want to clarify this to all potential candidates (and interviewers who read this): there is more than one way to calculate FCFF, depending on your starting point. Seems like some interviewers only know how to do this calculation when starting from EBIT and need to work backwards / forwards to get to EBIT as a starting point - see #2 below. This is unnecessary. There are other/faster ways to do it:
(1) Starting from Net Income:
Net Income + i (1-t) + D&A - Chg in NWC - Capex = FCFF / Unlevered FCF
(2) Starting from EBIT:
EBIT (1-t) + D&A - Chg in NWC - Capex = FCFF / Unlevered FCF
(3) Starting from EBITDA:
EBITDA (1-t) + D&A (t) - Chg in NWC - Capex = FCFF / Unlevered FCF
Am honestly surprised about how these interviewers didn't know how to do it via #1 and #3, but hope this is useful for anyone who is asked this question in the future.
I think it would be a value added for everyone if you included what the interview thought was the "correct" way to calculate it? If I read your first few sentences correctly, they asked "deaglet3, calculate FCFF starting from EBITDA."
I think it would be a value added for everyone if you included what the interview thought was the "correct" way to calculate it? If I read your first few sentences correctly, they asked "deaglet3, calculate FCFF starting from EBITDA."
For these types of questions its way easier to just get to EBIT and then follow the standard formula. Ex. EBITDA - D&A -> EBIT (1-t) + D&A - change in NWC - Capex.
Does it make more sense to you to do it your method? It just seems intentionally confusing
My gripe is not about which way is better. It's about how the person on the other side of the table is asking you a question that he himself doesn't have a firm grasp on. Method #3 is a perfectly acceptable way - you bypass having to subtract and re-add D&A.
Few people have memorized the approach from net income and EBITDA the way you described, so it's not a surprise there'd be a bit of confusion. But anyone competent should be able to work out quickly that the answer is in fact correct. If they are unwilling or unable to spend a moment doing that, then take it as a sign that it's not a good place to end up anyway, so not much of a loss. I had a few interviews where the interviewer wasn't too bright, and didn't understand what I was (correctly) saying, but again, that's a sign that you don't want to work there.
"that's a sign that you don't want to work there" is prob one of the most annoying things to hear and completely false in my opinion. If someone has a bad experience with ONE person at a firm that should not be a reason they do not want to work at that particular firm because that one person is just that, one person out of the entire firm and not indicative of what a persons experience will be at the firm.
Isn't #3 incorrect above? It is the same as #2.
What type of firms?
both were BB firms
Bankers like consistency. They need to check tons of work as quickly as possible. Why would you do something like #3 which is just algebraically making things harder to check? Lose-lose situation in an interview
To OP: You're right, on Excel, but you have to understand that in person, people are locked in to their particular order of operations and something deviating from that is going to be hard to follow.
It would be best to anchor them to EBIAT after your first two lines. For (2), this is obvious. For (1), you can say "We add back after-tax interest to net income to get EBIAT", which makes sense. For (3), you can say "We tax EBITDA at the effective rate, then add back the depreciation tax shield to get to EBIAT. That way, we account for the tax effects of depreciation without counting it as an expense."
Technically, all three of your approaches are sound, but I really think this is a communication issue more than an intelligence one. If you've taken computer science and had someone try to explain their (completely functional) code to you, you'll get the gist of what I mean, and why anchoring to something familiar is so important. Hope this helps.
@Quincyboy7:
^ This. Definitely agree that anchoring to EBIAT / NOPAT should be the way to approach questions asking to calculate FCFF from various points on the income statement. And very true on the 2nd point - once people get so used to doing it one way, they end up forgetting the intuition and it becomes mechanical almost. Thanks.
He's right dude. He doesn't add back D&A, he adds the tax shields that is associated with D&A expenses.
Calculating Free Cash Flow (Originally Posted: 02/09/2007)
Suppose we are attempting to calculate FCF to use in DCF and we are using WACC for the discount rate.
Is it (EBITDA -capex-workingcap), or (Net Income + DA-capex-workingcap)?
And when should EV/EBITDA be used versus P/E multiples?
EBIT*(1-t) + Depreciation - increases in net working cap (or + decreases in working cap) - capex +/- other non cash expenses
You should use a variety of multiples. EBITDA takes out accruals and expenses paid to debt holders (and therefore is a better proxy of cash available to financiers). Also, if a firm has no earnings but does generate EBITDA, its best to use the ebitda multiple.
FCF (Originally Posted: 08/14/2007)
Just a quick question about how things are done in IB. As an analyst, do you compute the FCF : 1) Taking Net Income + Dep/Amort ....then calculating the change in NetWorking Capital through individual lines AR, Inv, AP, Accr.Exp, ... 2)or do you just go directy to the CFS and do Operating CF - Capex?
I know the result is the same but I am just wondering if you kind of challenge the CFS or if you just assume that the CFS is correct and go with it.
I would assume it would be whichever gave a higher value?
NI to FCF and EBITDA to FCF
Either method is fine (assuming you meant to subtract Capex as well in your first method). However, you also need to subtract any management earnouts that are / would-be paid out. Earnouts should be treated the same as Capex in this context, since both are part of the cash flows from investing.
If you think about it, the two methods you proposed are the same, not just in terms of results but also in terms of steps - to do 2) starting with op cf requires you to have done 1) going from ni to op cf in the first place.
What you do see in most models, however, is the NI to FCF calculation on your cfs and the EBITDA to FCF calculation in your summary outputs - as a bridge and as a check.
FCF Formulas (Originally Posted: 01/03/2012)
I'm doing some reading in preparation for my SA stint, and I've read a few different sources and I notice they all have different definitions for FCF. So I was wondering if I could get a consensus on what the formulas are for:
FCFF FCFE Levered FCF and Unlevered FCF
Thanks.
For starters FCFF / unlevered free cash flow and FCFE / levered free cash flow tend to be interchangeable.
The first set represents the free cash flow available to the entire firm (hence the exclusion of the interest expense since you need to look at it sans cap structure) and the other set represents the cash flows available to the equity holders (hence the inclusion of interest expense to account for the cash outflows to debt holders).
Unlevered Free Cash flow = EBITDA - capex - change in WC - cash taxes
Levered Free Cash flow = EBITDA - capex - change in WC - cash taxes - cash net interest expense
Unlevered Free Cash flow = EBIT x (1- tax rate) + DA +/ changes in WC - capex (net of asset sales) +/- deferred taxes
Levered Free Cash flow = Net income - capex (net of asset sales) +/- change in WC +/- net borrowing
http://www.ibankingfaq.com/
that should help
Unlevered FCF = cash flow excluding costs, sources, and effects (e.g. on taxes) of funding (i.e. taxes, interest expense, interest income, debt amortisation, debt issuance/drawdown, dividends, equity issue proceeds, share buybacks etc)
FCFF = Unlevered FCF FCFE = FCFF excluding equity payments and funding (so the above excluding dividends, equity issue proceeds, share buybacks etc)
When prepping for interviews, it may be useful to memorize formulas, but when modelling, its better to understand what it actually means as that makes it easier to decide where every number goes .. otherwise you will perpetually be referring to templates and will never learn how to make a model fit whatever situation you're modelling for.
In any case, if you can practice modelling before your summer, do so, but don't waste time trying to learn rigid definitions. FCF definitions and usage is whatever your group wants it to be. Pointless learning to model by rigidly using Unlevered FCF -> Levered FCF, only to get stomped by models in your group using Operating FCF -> FCF -> Net Cash Flow
Technical Question on Calculating FCF (Originally Posted: 04/24/2013)
I would greatly appreciate any help on how to think about the following more accurately:
At b-school, I was taught to calculate FCF as follows: EBIT*(1-t) + D&A - Capex - changes in NWC. This gets you to unlevered FCF.
However, I often see investors calculating FCF as follows: EBITDA - Capex - Cash taxes - Cash interest expense.
My questions: What is the difference between these two methods? How does one calculate a firm's "cash taxes" and "cash interest expense" (actual formulas would be helpful here).
The deduction of interest expense in the 2nd method above implies a calculation of levered FCF, though there is no adjustment for changes in the debt's principal.
Thanks very much for any guidance.
I think that the formula "investors use" that you're talking about refers to more of an OCF metric, though it is, indeed, sometimes labeled FCF.
As for calculating cash taxes and cash interest expense, I don't understand what you mean by "actual formulas". They are fairly self-explanatory: cash taxes are the taxes that the company paid in cash for the period (as opposed to the income tax expense for GAAP purposes) and cash interest expense is the interest that the company paid in cash for the period (i.e. net of PIK interest, interest income, amortization of OIDs, etc.).
Ok, but how do I find what the company actually paid in cash taxes. It's not always explicitly stated in the notes to the financial statements. I've read that you add the increase in the company's deferred tax liability to the income tax provision found on the income statement, but I'm hoping for more clarity on how to think about this.
You can arrive at cash taxes by taking the income tax provision and subtracting the change in the DTL.
For example:
Say you had a company with $50 in operating income, with $20 of depreciation for tax purposes (MACRS schedule) and $10 for GAAP purposes (straight-line). Assume a 35% tax rate:
Tax return:
EBITDA: $50 Less D+A: ($20) EBT: $30 Taxes: ($10.5) Cash Tax Rate: $10.5 / $30 = 35%
GAAP Income Statement EBITDA: $50 Less: D+A: ($10) EBT: $40 Current Tax Expense: ($10.5) Deferred Tax Expense: ($3.5) GAAP Tax Rate: ($10.5 + $3.5) / $40 = 35% Cash Taxes: $10.5
For the period, you'd see a $3.5 increase in the Deferred Tax Liability on the B/S, which would be added back to net income on the cash flow statement.
...have you checked the cash flow statement?
Of course, cash taxes are often listed in a supplemental disclosure in the CF statement, but not always. When it's not, how can I arrive at it? And how can I estimate it going forward? Is there a generally accepted way to model this?
Thanks
For me, FCF = Cash Flow from Operations - CAPEX
I like normalizing the tax rate in my FCF calculations unless a company has a complex, persistent tax situation.
Cash interest expense is usually given in the filings. The "formula" would just be O/S debt * cash coupon rates.
FCF= EBITDA - Capex - Cash Interest - Cash Tax - Change in Working Capital and this is FCFE
I suggest doing a consensus and in case nothing is disclosed (which is rare) just use the P&L figures for cash tax and for Cash interest Coupon*Average Outstanding Debt. In case you have done detailed analysis NOLS valuation will be used as cash tax
Cash interest - you need to account for accruals. add PY accrual (b/c cash paid in CY) subtract CY accrual (no cash paid).
Edit
FCF Question (Originally Posted: 01/02/2008)
Okay, I feel silly asking this since it's kinda basic but I just want to clarify.
I was under the impression that FCF = EBIT(1-T) + D/A - Change in Net Wkg. Capital - CAPEX.
However, I've also read that FCF = NI + D/A - Chng. Net. Wkg. Capital - CAPEX.
Whats the difference? Is one calculating FCF and the other one doing residual FCF?
Thanks in advance
Although I would take issue with the exact methodology for the second formula, the difference is primarily the first is the unlevered free cash flow (ULFCF) calculation while the second approximates a levered free cash flow (LFCF) calculation. LFCF is the free cash flows after taking into account the capital structure of the firm, hence the inclusion of the after-tax interest charge.
Using EBIT*(1-T) is technically and theoretically correct. The reason being is that it uses the taxes as if there were no debt (think "hypothetical taxes.") The tax savings are accounted for in the discount rate (cost of debt cheaper due to tax deductible interest rate). Therefore, if you use NI as your starting point you're double counting tax savings.
Thanks guys, it just kinda clicked again.
Appreciate the help as always
Hopefully this will be more of a help than a hindrance, but it's often important to consider exactly who's FCF it is. For instance, there are formulas to compute either FCF for the Firm (which will service debt (interest), then government (tax), then owners (equity)). However, if you're an equity investor, the FCF to the firm is something you could care less about if its all or mostly taken by debt holders and the government. As an equity investor, you'd be inclined to look at FCF to equity, rather than to the whole firm.
FCF (firm) = EBIT(1-t) +D&A -CapEx -Change in WC
FCF (equity) = NI -(D&A-CapEX)(1-Debt/Capital) -(Change in WC)(1-Debt-Capital)
In the equity equation, you multiply by 1-debt to capital because this will leave you with the adjustment for solely equity.
Visit www.damodaran.com to learn more about these concepts. He is a renowned professor at Stern, and has a robust website with massive amounts of info on Corp. Fin, Valuation and other topics.
Firstly, if you can calculate the value of the firm through the fcf to the firm, then you implicitly know the value of the debt and preferred (needed to arrive at WACC or tax shield for APV). Similarly, if you can calculate the value of the equity through the fcf to the equity, then you implicitly know the value of the debt and preferred (needed to calculate the equity cost of capital). Therefore, both methods if implemented correctly are mathematically equivalent.
Secondly, I am almost certain that your free cash flow to equity calculation is wrong. Logically thinking about the equation, -(D&A-Capex) = -D&A+Capex, whereas it should be +D&A and -Capex. Similarly, it doesn't make sense to multiply (1-Debt/Capital), because the amount of D&A, capex, and working capital should not change (theoretically) with capital structure. Also, the debt and preferred claimholders are senior to equity, and it would not make sense to make adjustments on top of those already subtracted through net interest and preferred dividends. The equation in its most basic form, then, not considering the many adjustments that would have to be made to make this mathematically correct, is FCF(equity)=NI to common equity + D&A - Change in Working Capital - Capex, as was stated initially.
Yeah, my FCFE equation was totally messed up, my apologies. I think Damodaran does go through some simplification/approximation of/for FCFE using the Debt to Cap ratio, if you can find it on his website.
FCF - which one (Originally Posted: 08/03/2007)
hi,
I've found 2 methods to calculate the Free Cash Flow, which one should I use during an interview and what is the difference?
1) FCF = EBIT*(1-t) + Depreciation/Amortization - Capex - Net Increase in WC 2) FCF = Net Income + Depreciation/Amortization - Capex - Net Increase in WC
Is the second one what we call the Free Cash Flow to Equity or something like that since interest has already been deducted therefore this FCF should be only for the shareholders...I need this to be clarified. What should you answer when someone ask you to define the FCF during an interview? It seems the 1st one no?
one's levered and the other is unlevered
Thanks Opticalcharge
Use the first by default.
No one adds back stuff to net income to get FCF in practice. For a large company there's so much contamination in net income, you'd spend a year making adjustments.
But you still want to be prepared if they quiz you on the net income method.
how come my intro to accounting class tells me FCF is just operating cash flow minus capital expenditures... dirty liars...
In the FCFE formula you need to add the change in debt position, i.e. New Debt - Principal Repayments
And what would this number be useful for?
FCF to equity is used in LBO modeling. Generally, we assume that all or nearly all of the cash available after paying interest expense is used to service debt.
Unlevered Net Income can be used in a DCF (in conjunction with WACC), where you're trying to value operating cash flows to arrive at an "intrinsic" enterprise value.
Note that if you're valuing a company with no outstanding debt, preferred stock or minority interest FCF to equity equals unlevered net income.
You mean unlevered cash flow. There will be differences arising from depreciation v capex and the tax treatment in the P&L v the tax return. Only true if that company has no debt and no cash. Even if the company has no net debt, a difference will arise on interest received on cash v interest paid on debt.
Wow...somebody just got punked haha.
In any case, to add to the first portion of the above comment, yes, it is theoretically incorrect to assume that all free cash flow (levered) is used to pay down all debt, but it is general practice to assume that optional repayment of bank debt is allowed, whereas more junior debt stays constant.
It wasn't my intention to "punk" anyone - just to correct the inaccuracies in case anyone relies on this in an interview.
Yes, in practice it's easiest to assume that the excess cash goes to pay down debt. There's 3 things a company can do with excess cash; 1) Return it to shareholders (as ordinary or exceptional dividends or share buybacks) 2) Use it for acquisitions 3) Net it off against debt
For 1, unless the company has announced a change in the dividend policy, buyback or target debt level this cannot be anticipated.
For 2, without knowing what the company is going to buy (or what price it will have to pay), this cannot be modelled into forecasts.
Given the impracticalities of anticipating 1 or 2, the default for modelling is usually 3. The difference between received interest rate and paid interest rate is usually immaterial to the P&L unless the leverage is extremely high. Most analysts (I mean research analysts here) don't care enough to take the time to model it correctly and just apply an average effective rate to the overall net debt.
FCF Calculation Confusion Question (Originally Posted: 08/25/2017)
Hey all,
I've been tasked to derive an enterprise value for a mall that will begin operations as of 2018. I'm attempting to attain the FCF but something is confusing me and it is the following:
Balance Sheet: Year 0 (2017)
Cash 22,000,000 Assets: 22,000,000
Long term debt: 12,000,000 Equity:10,000,000 Liab + Equity: 22,000,000
Balance Sheet: Year 1 (2018)
Net fixed assets: 21,750,000 Cash: 250,000 Assets: 22,000,000
Long term debt: 12,000,000 Equity: 10,000,000 Liab + Equity: 22,000,000
My questions are the following:
Do we start FCF at year 0 or year 1? Im confused because im not sure if the capital expenditure of 21,750,000 should be included in the FCF. If they purchased the equipment in year 0 and we started the FCF at year 1 then FCF would be decreased by 21.75 million in year 1, but then if fixed assets on the balance sheet were reported under year 0 then fixed assets would be 21,750,000 and 21,750,000 in years 0 and 1 and hence the difference would be 0 and FCF would not decrease by 21,750,000...
Thanks!
Note: No depreciation was reported in.
They spent the capex in year 1...ergo your cash flow from investing will go down by 21.75m
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