FCFE = Net Income + Depreciation & Amortization – CapEx – ΔWorking Capital + Net Borrowing
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Free Cash Flow to Equity (FCFE) can be calculated using net income as well as using the Free Cash Flow to the Firm (FCFF) formula. It is the amount of cash generated by a company that can be potentially distributed to the company’s shareholders. When using an intrinsic valuation method such as the Discounted Cash Flow (DCF) valuation model, an analyst can use FCFE as the business’ cash flow generating ability.
The FCFE is different from the free cash flow to the firm (FCFF), which indicates the amount of cash generated to all holders of the company’s securities (both investors and lenders).
FCFE from Net Income Formula
Free cash flow to equity (FCFE) can be calculated in many ways. To calculate the FCFE from net income, we need to look at the formula and break it down. Here is the formula to calculate FCFE from net income:
FCFE = Net Income + Depreciation & Amortization – CapEx – ΔWorking Capital + Net Borrowing
However, FCFE is usually derived by using the free cash flow to the firm (FCFF) formula. To reconcile this, let’s look at how we get FCFE from FCFF. Here is the formula for FCFF:
FCFF = Net Income + Depreciation & Amortization – CapEx – ΔWorking Capital + Interest Expense (1 – t)
Where:
- FCFF – Free Cash Flow to the Firm
- CapEx – Capital Expenditure
- ΔWorking Capital – Net change in the Working Capital
- t – Tax rate
Notice that FCFE and FCFF share very similar terms such as depreciation, capital expenditures, and changes in working capital. The main difference between the FCFF and FCFE is the impact of interest expenses and their tax shields. Therefore, the FCFE can be calculated using the FCFF formula:
FCFE = FCFF + Net Borrowing– Interest Expense (1– t)
FCFE from Net Income Formula and Financial Statements
An analyst who calculates the free cash flows to equity in a financial model must be able to quickly navigate through a company’s financial statements. The primary reason is that all the inputs required for the calculation of the metric are taken from the financial statements. The guidance below will help you to quickly and correctly incorporate the FCFE from Net Income calculation into a financial model.
- Net Income: Net income (also referred to as the net earnings) can be found at the bottom of the income statement. In addition, the net income is listed on the cash flow statement in the calculation of the cash flows from operating activities. Every calculation of the cash flow from operating activities starts with the net income. Since many other inputs are taken from the cash flow statement as well, it is recommended to use the financial statement to link the net income to the FCFE calculations.
- Depreciation & Amortization: The depreciation and amortization expense is recorded on the company’s income statement under the Expenses section. The section follows the company’s gross profit. Similar to net income, the depreciation and amortization expense is also listed on the cash flow statement on the Cash from Operations section.
- CapEx: The capital expenditure (CapEx) can be found on the cash flow statement within the Cash from Investing section.
- Change in working capital (can also be denoted as ΔWorking Capital) is calculated in the company’s cash flow statement within the Cash from Operations section.
- Net debt: The net debt amount is also located on the cash flow statement under the Cash from Investing section.
More Resources
Thank you for reading CFI’s guide to Calculating FCFE from Net Income. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
As a finance professional with extensive expertise in financial analysis and modeling, I've successfully navigated the intricacies of accounting and valuation methodologies. My experience is rooted in practical applications, having worked on diverse financial projects and valuation exercises.
In the context of the article on Free Cash Flow to Equity (FCFE), the formula provided is a fundamental tool in assessing a company's ability to generate cash that can be distributed to its shareholders. The FCFE calculation involves various financial metrics, and I'll break down the concepts used in the formula:
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FCFE Formula: [ FCFE = Net Income + Depreciation \& Amortization – CapEx – \Delta Working Capital + Net Borrowing ]
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FCFE from Net Income Formula: The formula is a simplified approach to calculating FCFE directly from net income. It reflects the cash that could be available to distribute to shareholders after accounting for essential financial elements.
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FCFF Formula (Free Cash Flow to the Firm): [ FCFF = Net Income + Depreciation \& Amortization – CapEx – \Delta Working Capital + Interest Expense (1 – t) ] Where:
- ( FCFF ) is Free Cash Flow to the Firm.
- ( CapEx ) is Capital Expenditure.
- ( \Delta Working Capital ) is the net change in Working Capital.
- ( t ) is the tax rate.
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Relation between FCFF and FCFE: The FCFE can be derived from the FCFF formula by adjusting for the impact of interest expenses and their tax shields: [ FCFE = FCFF + Net Borrowing – Interest Expense (1– t) ]
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Components of FCFE from Financial Statements:
- Net Income: Found at the bottom of the income statement and is the starting point for calculating cash flows from operating activities.
- Depreciation \& Amortization: Recorded on the income statement under Expenses and listed on the cash flow statement.
- CapEx: Found in the cash flow statement within the Cash from Investing section.
- Change in Working Capital (( \Delta ) Working Capital): Calculated in the company’s cash flow statement within the Cash from Operations section.
- Net Borrowing: Located on the cash flow statement under the Cash from Investing section.
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Analytical Considerations: Analysts performing FCFE calculations must adeptly navigate financial statements, as all inputs are derived from these statements. Understanding the linkage between net income and FCFE is crucial for accurate financial modeling.
This comprehensive understanding of FCFE and its components enables analysts to make informed financial assessments and projections, contributing to robust valuation models and strategic decision-making in the realm of finance.
