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Differentiate between FCFF and FCFE
Let us understand what free cash flow to firm (FCFF) and free cash flow to equity are, before learning about their differences.
Free cash flow to firm (FCFF)
Free cash flow is an integral measurement tool which is used in management accounting. This allows business members to monitor and measure the values of their business to avoid failure and to expand their business by keeping features needs in mind.
In simple words, free cash flow is the leftover money in the firm after deducting all the expenses like debts, expenses, rent etc. It also indicates the health of the company. By free cash flow, owners can measure their firm’s growth and success.
If a firm is having excess or more cash flow then, they can use it to buy an asset, expand their business, pay dividends to stakeholders etc.
Moreover, if they are interested they can go for acquisition. Similarly, if the firm is having more negative cash flow, they can reassess their strategies and invest wisely in the future.
Any firm can increase their cash flow by restructuring their debts; optimising repayment, limiting their capital expenditures, improving their financial strategies.
Free cash flow to equity (FCFE)
It is the amount which is distributed by a company to their shareholders in the form of dividends or buybacks. The amount is calculated after deducting from the operational needs, paying outstanding debts etc.
It is similar to the Dividend Discount Model (DDM).
Sometimes, the firm may pay higher dividends even though they have low free cash flow to equity, simply by issuing new securities/ pay out dividends with existing debt/capital. Companies will have negative free cash flow to equity, due to negative net income and will have negative cash out flow due to change in working capital, settling their debts, sizable capital expenditure.
Differences
The major differences between free cash flow to firm(FCFF) and free cash flow to equity (FCFE) are as follows−
| Sr.No | Free cash flow to firm (FCFF) | Free cash flow to Equity (FCFE) |
|---|---|---|
| 1 | Cash flow is available to all the investors of a firm. | Cash flow is available for equity shareholders only. |
| 2 | Unlevered cash flow as leverage impact is excluded. | Levered cash flow as leverage impact is included. |
| 3 | Calculates enterprise value. | Calculates equity value. |
| 4 | Weighted average cost of capital is included in capital structure. | Cost of equity is used to maintain consistency. |
| 5 | Preferred by companies with high leverage. | Preferred by analysts. |
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