We define free cash flow as the cash that is available to the firm’s investors, including both bond and stock investors. Free Cash flow (FCF) is the cash available after the company pays for its cash operating expenses, after the company buys and sells their products or services, and after they make any short-and-long-term investments.
The image is a screenshot of the video which brief illustrates how a company goes about creating free cash flow.
Free Cash Flow to the Firm (FCFF)
The generation of Free cash flow to the firm occurs after the company pays their operating expenses and after they make short-and-long-term investments. You can generally find these investments on the capital expenditures line of their cash flow statement. A shortcut to calculating free cash flow to the firm is to take cash flow from operations (from the cash flow statement) and subtracting capital expenditures, CAPEX for short (also from the cash flow statement).
A shortcut to calculating free cash flow to the firm is to take cash flow from operations (from the cash flow statement) and subtracting capital expenditures, CAPEX for short (also from the cash flow statement)
Free Cash Flow to Equity (FCFE)
Once you have free cash flow to the firm, you can calculate free cash flow to equity rather easily simply by accounting for the fact that free cash flow to equity is what you get after bond investors are taken care of. As the illustration points out, bond investor interest must be paid, principal – if any is due, and if the company elects to issue more bonds, well that would be added. What remains is how much is available for equity investors (aka stock investors).
So free cash flow to equity is what remains for investors in the company’s stock after funding working capital needs, Fixed capital needs and debt financing. Now, this isn’t necessarily what the stock investors get. The board of directors still gets to decide that. The company can return that cash to investors via buybacks or dividends. Or the company can elect to hold that cash and reinvest in the company, perhaps they could acquire another company, or maybe they choose to save it for a rainy day.