What is the point of FCF if it doesn't include debt and interest payments?
Why does everyone look at free cash flow when the common formula (Total Cash Flow From Operating Activities - Capital Expenditures) does not take into account things like interest expense (or any taxes or debt payments at all?)
Basically - who cares about a company's ability generate cash (before the big payments) if it's drowning in debt? Wouldn't a better formula have everything a firm has spent that quarter (or year) and then whatever is left (or isn't) is their "leftover cash"/Free Cash Flow.
COTY, for instance, shows that they generate $567 million last quarter, but this is before they have to pay off their debt.
When is debt included in free cash flow calculation?
Here are some highlighted responses from the community
from certified user @kallester"
Firstly, taxes are included. Secondly, read up on the differences between FCFF and FCFE. The FCFF (the one that doesn't take into account interest payments) gives you a sense of the company's value regardless of who the investors are.
Theoretically, the FCF should be used for a) Reinvestments b) equity holders and/or c) debt holders, so if you've started applying the FCFE method, you've decided to steer away from looking at the core value of the business and instead started figuring out what its capital structure is.
from certified user @Masterz57"
A further point to what has been listed above is that FCF answers two critical questions: 1) are the business operations generating cash as a going concern? and 2) what cash is available to ALL layers of the capital structure (debt+equity). When looking at a company's ability to service debt there are other factors that need to be considered beyond FCF. For instance, imagine a company (and yes this is an extreme scenario) where FCF is 100, interest expense is 105, and cash/ST securities are 5,000. Would you be concerned that the company cannot cover their debt payments? Alternatively, maybe that quarter there was a steep rise in a LIBOR+ loan package and so they had to fund some of the interest expense out of cash on hand. One thing to remember when looking at debt is that there are many factors to consider beyond interest expense - volatility of cash flow, liquid assets, repayment schedules, ability to refinance, etc. Another thing to remember is that very, very few entities have a vested interest in a company going bankrupt. It's generally good for no one (equity holders, debt holders, management) and so all parties tend to go to extreme lengths to prevent it from happening.
Because if debt was a problem and you didn't consider FCF but a CF after debt , it would seem (from this number alone) that the company cannot make money. But the real information is that the company has a big debt.
You need FCF to evaluate the company's ability to generate cash as a business.
But that's what you want to find out - can the company make money after all expenses are paid? Total Cash Flow From Operating Activities - Capital Expenditures does not clue you in on if they can make money because you're omitting expenses.
With the common formula you're not factoring in major expenses the company has yet to pay.
It answers the important question :Is the operations sound? You need to distinguish if the big or small CF(relative to comparables) comes from bad business (customers don't pay in time, suppliers giving you no credit) or its because of small / big debt and other externalities.
It hugely depends on which piece of information you want
Firstly, taxes are included. Secondly, read up on the differences between FCFF and FCFE. The FCFF (the one that doesn't take into account interest payments) gives you a sense of the company's value regardless of who the investors are.
Theoretically, the FCF should be used for a) Reinvestments b) equity holders and/or c) debt holders, so if you've started applying the FCFE method, you've decided to steer away from looking at the core value of the business and instead started figuring out what its capital structure is.
Great - looks like I got some homework to do. Thanks!
This post shows your inexperience, which is ok. FCF, like most of everything in valuation, is not set in stone, rather it depends on who's looking at it and its intended purpose. Actually, if the focus is on debt paydown/debt servicing, these outflows are included in FCF.. In a DCF for IB valuations, they're not looked at because a buyer typically pays for everything, as captured in EV, given that value is irrespective of capital structure. In fact, FCFE is used when valuing the equity portion alone to include these payments to understand what's left over for the shareholders.
A further point to what has been listed above is that FCF answers two critical questions: 1) are the business operations generating cash as a going concern? and 2) what cash is available to ALL layers of the capital structure (debt+equity). When looking at a company's ability to service debt there are other factors that need to be considered beyond FCF. For instance, imagine a company (and yes this is an extreme scenario) where FCF is 100, interest expense is 105, and cash/ST securities are 5,000. Would you be concerned that the company cannot cover their debt payments? Alternatively, maybe that quarter there was a steep rise in a LIBOR+ loan package and so they had to fund some of the interest expense out of cash on hand. One thing to remember when looking at debt is that there are many factors to consider beyond interest expense - volatility of cash flow, liquid assets, repayment schedules, ability to refinance, etc. Another thing to remember is that very, very few entities have a vested interest in a company going bankrupt. It's generally good for no one (equity holders, debt holders, management) and so all parties tend to go to extreme lengths to prevent it from happening.
No interest rate deductibility? How to calculate new FCF? (Originally Posted: 03/29/2017)
So big headline around tax reform is the likelihood of eliminating interest expense deductibility. Just want to confirm my thought here that if this actually happens it would change how you calculate FCF. Basically you will have to deduct estimated tax expense before you get "unlevered" FCF, then if you want to work down to "levered FCF" you'd just have to deduct interest expense (which is now after tax).
Basically you lose the tax shield on interest expense and it brings unlevered and levered FCF closer together.
Obviously the WACC calculation will be effected as well, since cost of debt will lose its tax shield.
Can anyone else chime in and let me know if they agree with my analysis or if I'm thinking about this wrong? Any other thoughts for major knock on consequences? Obviously highly levered companies would be in a tough position if there is no provision for existing debt (which, last I heard, there isn't).
bump?
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