Free Cash Flow to Equity (FCFE) Formula and Example

What is Free Cash Flow to Equity (FCFE) Formula?

Free Cash Flow to Equity (FCFE) is a financial metric used to measure the amount of cash that is available to be distributed to the equity shareholders of a company after all expenses, investments, and debt payments have been accounted for. It represents the cash flow that is available to the company’s equity holders, which can be used for dividends, share buybacks, or reinvestment in the business.

Definition and Explanation

Free Cash Flow to Equity (FCFE) is calculated by subtracting capital expenditures and changes in net working capital from the company’s operating cash flow and adding back any net borrowing or debt repayments. The formula can be expressed as:

Free Cash Flow to Equity (FCFE) is an important metric for investors and analysts as it provides insight into the company’s ability to generate cash that can be distributed to shareholders. It is often used in valuation models to determine the intrinsic value of a company’s equity.

How to Calculate Free Cash Flow to Equity (FCFE)

How to Calculate Free Cash Flow to Equity (FCFE)

To calculate Free Cash Flow to Equity (FCFE), you will need the following information:

  1. Operating Cash Flow: This can be found in the company’s cash flow statement and represents the cash generated from the company’s operations.
  2. Capital Expenditures: This can be found in the company’s financial statements or notes to the financial statements and represents the cash used for investments in fixed assets.
  3. Change in Net Working Capital: This can be calculated by subtracting the current net working capital from the previous net working capital. Net working capital is calculated by subtracting current liabilities from current assets.
  4. Net Borrowing/Debt Repayments: This can be found in the company’s financial statements and represents any net borrowing or debt repayments made during the period.

Once you have gathered this information, you can use the formula mentioned earlier to calculate Free Cash Flow to Equity (FCFE).

Example of Free Cash Flow to Equity (FCFE) Calculation

Let’s say a company has an operating cash flow of $1,000, capital expenditures of $500, a change in net working capital of $200, and net borrowing/debt repayments of $100. Using the formula, the Free Cash Flow to Equity (FCFE) would be:

This means that the company has $400 of cash available to distribute to its equity shareholders after all expenses, investments, and debt payments have been accounted for.

Real-Life Scenario

Free Cash Flow to Equity (FCFE) is a valuable metric for investors and analysts as it provides insight into a company’s financial health and its ability to generate cash that can be distributed to shareholders. By analyzing a company’s FCFE, investors can assess the company’s ability to pay dividends, repurchase shares, or invest in growth opportunities. It can also be used in valuation models to determine the intrinsic value of a company’s equity.

Definition and Explanation

Free Cash Flow to Equity (FCFE) is a financial metric that measures the amount of cash flow available to the equity shareholders of a company after all expenses, investments, and debt payments have been accounted for. It represents the cash that can be distributed to the company’s equity holders, such as shareholders or owners, without affecting the company’s operations or financial stability.

FCFE is an important indicator of a company’s financial health and its ability to generate cash for its shareholders. It is often used by investors and analysts to assess the value and profitability of a company, as well as its ability to pay dividends or repurchase shares.

To calculate FCFE, several financial statements and metrics are taken into consideration, including the company’s net income, capital expenditures, changes in working capital, and debt repayments. By subtracting these expenses from the company’s operating cash flow, FCFE provides a more accurate representation of the cash available to equity shareholders.

FCFE is different from Free Cash Flow to Firm (FCFF), which measures the cash flow available to all stakeholders, including both equity and debt holders. FCFE focuses specifically on the equity shareholders and excludes the impact of debt financing.

How to Calculate Free Cash Flow to Equity (FCFE)

Calculating Free Cash Flow to Equity (FCFE) is an important step in evaluating a company’s financial health and its ability to generate cash flow available to its equity shareholders. FCFE represents the cash flow that is available to the company’s equity investors after all expenses, investments, and debt obligations have been accounted for.

Step 1: Calculate Net Income

The first step in calculating FCFE is to determine the company’s net income, which can be found on the income statement. Net income represents the company’s total revenue minus all expenses, including taxes.

Step 2: Adjust for Non-Cash Expenses

Next, you need to adjust the net income for any non-cash expenses, such as depreciation and amortization. These expenses do not require an actual outflow of cash and should be added back to the net income.

Step 3: Account for Changes in Working Capital

Changes in working capital, such as accounts receivable, accounts payable, and inventory, can impact a company’s cash flow. To calculate FCFE, you need to adjust for these changes. If there is an increase in working capital, it should be subtracted from the adjusted net income, while a decrease should be added.

Step 4: Deduct Capital Expenditures

Capital expenditures (CAPEX) represent the investments a company makes in its fixed assets, such as property, plant, and equipment. To calculate FCFE, you need to subtract the CAPEX from the adjusted net income and changes in working capital.

Step 5: Add or Subtract Net Borrowing

If a company has borrowed or repaid any debt during the period, it should be accounted for in the FCFE calculation. If the company has borrowed, the net borrowing amount should be added to the result of Step 4. If the company has repaid debt, the net borrowing amount should be subtracted.

Step 6: Calculate Free Cash Flow to Equity (FCFE)

Finally, to calculate FCFE, you need to subtract the net borrowing amount (Step 5) from the result of Step 4. The resulting value represents the cash flow available to the company’s equity shareholders.

By calculating FCFE, investors and analysts can assess a company’s ability to generate cash flow that can be distributed to its equity shareholders, reinvested in the business, or used to pay down debt. This metric is particularly useful when evaluating companies with high levels of debt or those that pay dividends to their shareholders.

Step-by-Step Guide to Calculate Free Cash Flow to Equity (FCFE)

Calculating Free Cash Flow to Equity (FCFE) is an important financial analysis tool that helps investors and analysts assess a company’s ability to generate cash flow available to its equity shareholders. Here is a step-by-step guide on how to calculate FCFE:

Step 1: Determine Net Income

Start by finding the net income of the company, which can be obtained from the income statement. Net income represents the profit generated by the company after deducting all expenses and taxes.

Step 2: Adjust for Non-Cash Expenses

Step 3: Account for Changes in Working Capital

Consider changes in working capital, which includes current assets (such as accounts receivable and inventory) and current liabilities (such as accounts payable and accrued expenses). Subtract the increase in working capital from the adjusted net income.

Step 4: Account for Capital Expenditures

Step 5: Account for Net Borrowings

Consider any net borrowings made by the company during the period. Net borrowings include both long-term borrowings (such as loans) and short-term borrowings (such as lines of credit). Add the net borrowings to the result obtained in Step 4.

Step 6: Calculate Free Cash Flow to Equity (FCFE)

The final step is to calculate the FCFE by subtracting the dividends paid to equity shareholders from the result obtained in Step 5. Dividends represent the cash distributed to the company’s shareholders.

By following these steps, investors and analysts can determine the FCFE, which provides insights into a company’s financial health and its ability to generate cash flow that can be distributed to equity shareholders.

Example of Free Cash Flow to Equity (FCFE) Calculation

Let’s consider a hypothetical company, XYZ Corp, to understand how to calculate Free Cash Flow to Equity (FCFE).

Step 1: Gather the necessary information

Before calculating FCFE, we need to collect some financial data from XYZ Corp’s financial statements. This includes:

  • Net Income: $500,000
  • Depreciation and Amortization: $100,000
  • Capital Expenditures: $200,000
  • Changes in Working Capital: $50,000
  • Interest Expense: $75,000
  • Tax Rate: 30%

Step 2: Calculate Operating Cash Flow (OCF)

Step 2: Calculate Operating Cash Flow (OCF)

First, we need to calculate the operating cash flow (OCF) by subtracting depreciation and amortization from net income:

OCF = Net Income + Depreciation and Amortization

OCF = $500,000 + $100,000 = $600,000

Step 3: Calculate Capital Expenditures (Capex)

Next, we need to calculate the capital expenditures (Capex) by subtracting the changes in working capital from the total capital expenditures:

Step 4: Calculate Free Cash Flow to the Firm (FCFF)

Step 4: Calculate Free Cash Flow to the Firm (FCFF)

Now, we can calculate the free cash flow to the firm (FCFF) by subtracting the capital expenditures from the operating cash flow:

Step 5: Calculate Interest Tax Shield

Next, we need to calculate the interest tax shield by multiplying the interest expense by the tax rate:

Interest Tax Shield = Interest Expense * Tax Rate

Interest Tax Shield = $75,000 * 30% = $22,500

Step 6: Calculate Free Cash Flow to Equity (FCFE)

Finally, we can calculate the free cash flow to equity (FCFE) by subtracting the interest tax shield from the free cash flow to the firm (FCFF):

Therefore, the free cash flow to equity (FCFE) for XYZ Corp is $427,500.

This calculation provides valuable information to investors and analysts as it represents the cash available to the company’s equity shareholders after all expenses, reinvestments, and debt obligations have been taken into account. It can be used to assess the company’s ability to pay dividends, repurchase shares, or invest in growth opportunities.

Real-Life Scenario

Real-Life Scenario

Company XYZ

Imagine we are analyzing Company XYZ, a multinational technology company. We want to determine the FCFE of the company to assess its ability to generate cash flow available to equity shareholders.

First, we gather the necessary financial information, including the company’s net income, capital expenditures, changes in working capital, and net borrowings. We also consider any dividends paid to equity shareholders.

Let’s say Company XYZ reported a net income of $100 million, capital expenditures of $50 million, a decrease in working capital of $10 million, net borrowings of $20 million, and dividends paid to equity shareholders of $30 million.

This means that Company XYZ generated $150 million in free cash flow available to its equity shareholders during the specified period.

By analyzing the FCFE, investors and financial analysts can assess the company’s ability to fund future growth, repay debts, and distribute dividends. A positive FCFE indicates that the company has surplus cash flow available to equity shareholders, while a negative FCFE suggests that the company may need to rely on external financing or reduce dividend payments.

Additionally, comparing the FCFE of Company XYZ with its competitors or industry averages can provide insights into its financial performance and competitive position. A higher FCFE relative to peers may indicate a stronger financial position and potential for future growth.