What is Free Cash Flow to Equity?
Free Cash Flow to Equity (FCFE) is a financial metric that measures the cash flow available to the equity holders of a company after accounting for payments to debt holders and any reinvestment in the company’s operations. This calculation is used to determine the returns that can be provided to equity holders and potential investors. FCFE is an important metric for investors and analysts as it provides more accurate insight into a company’s performance than some other measures of profitability.
Calculating Free Cash Flow to Equity
The FCFE formula starts by taking Cash Flow from Operations (CFO), then subtracting Capital Expenditures (Capex) and adding Net Borrowing. This calculation is done in order to measure the availability of cash to shareholders or equity holders. For example, if a company has a CFO of $100,000 and a Capital Expenditure of $50,000 and suffers no net borrowing, then the FCFE would be $50,000 after accounting for payments to debt holders and Capex.
When to Use FCFE
FCFE is a useful tool when evaluating a company’s profitability for potential investors. It is especially useful in situations where the company is issuing shares or taking out loans, as it provides a more accurate measure of the cash available to equity holders. FCFE is also helpful for comparing companies within the same industry, as it captures the true cash-generating ability of a company without accounting for possible differences in how each company is funded. As such, FCFE can provide a more accurate assessment of a company’s overall profitability and long-term prospects. The FCFE formula is:
FCFE = Net Income + (Noncash Expenses – Noncash Revenues) + (Change in Working Capital + Investment in Operating Assets – Dividend Payment)
where
Net Income = Operating Revenues – Operating Expenses
Noncash expenses = Amortization, Depreciation
Noncash revenues = Adjustments for items such as Deferred Taxes
Change in Working Capital = Current Assets – Current Liabilities / Previous period Assets – Liabilities
Investment in Operating Assets = Capital Expenditures (CAPEX)
Dividend payment = cash payouts to shareholders
FCFE (Free Cash Flow to Equity) is a measure of how much cash is available to shareholders after all operating expenses, investments and dividends are paid. It can be used to help determine a company’s value and help inform shareholders regarding how well the company is being managed. FCFE is an important metric when evaluating a company’s performance and financial health.
