Free Cash Flow to Firm

Free cash flow to firm (FCFF) (also referred to as just the free cash flow) of a company is the cash flow in an accounting period which is available for distribution to the company’s debt-holders and equity-holders. FCFF equals net income adjusted for any non-cash expenses or incomes and working capital changes minus capital expenditures incurred during the period.

Free cash flow to firm is different from free cash flow to equity (FCFE) in that the FCFF determines cash available for distribution to providers of capital regardless or whether they are debt-holders or stock-holders but FCFE determines net cash available for the equity-holders after subtracting after-tax interest expense.


The exact calculation for free cash flow to firm depends on the starting point.

Starting with net income for a period, we must (a) add non-cash expenses such as depreciation expense, deferred taxes, bad debts, etc.; (b) subtract any non-cash gains such as gain on sale of fixed assets, foreign exchange gains, etc.; (c) add after-tax interest expense, (d) adjust for working capital i.e. add decrease in current assets or increase in liabilities and subtract increase in current assets or decrease in current liabilities, and (e) subtract capital expenditures

This is expressed by the following formula:

$$ FCFF=NI+NCE-NCI+I×(1-t)±WC-FC $$

Where NI is net income, NCL is the non-cash expenses, NCI is non-cash incomes, I is interest expense, t is tax rate, WC represent the net working capital adjustment and FC stands for net capital expenditures. Because some companies do not subtract interest expense in calculating cash flows from operations and instead subtract them as part of cash flows from financing activities, no after-tax interest expense must be added in such cases.

Starting with cash flow from operations, we just need to add after-tax interest expense (if has been subtracted in calculation of CFO) and subtract net capital expenditures

$$ FCFF=CFO+I×(1-t)-FC $$

Valuation using FCFF

Free cash flow to firm (FCFF) is discounted at the weighted average cost of capital to determine the value of a company i.e. the value of a company as a whole. The market value of its debt is then subtracted to arrive at the value of the company’s equity. Following are the formulas that can be used to determine the company value and the equity value:

$$ V_A=\frac{{\rm FCFF}_0\times\left(1+g\right)}{wacc-g} $$

$$ V_E=V_A-MVD=\frac{{\rm FCFF}_0\times\left(1+g\right)}{wacc-g}-MVD $$

Where FCFF0 is the free cash flow in the most recently completed financial year, g is the growth rate of FCFF, WACC is the weighted average cost of capital and MVD is the market value of debt.

Multi-stage models can also be used to incorporate different growth rates for different periods.

Free cash flow to firm valuation model is appropriate when the company do not pay dividends or where the dividends are disproportionate to the company’s earnings.

Written by Obaidullah Jan, ACA, CFA and last modified on