fcff from ebitda conversion and analysis

FCFF from EBITDA conversion and analysis is a crucial step in evaluating a company's financial health.

FCFF stands for Free Cash Flow to the Firm, which is a key metric in determining a company's ability to generate cash.

To convert EBITDA to FCFF, you need to consider several factors, including capital expenditures, changes in working capital, and tax payments.

A common formula used for this conversion is EBITDA - (Capital Expenditures + ΔWorking Capital + Taxes).

Broaden your view: Working Capital and the Current Ratio Are Measures of

To calculate FCFF from EBITDA, start with EBITDA, which is $25m in our example. We then deduct $5m in D&A to get $20m as the EBIT.

From the $20m of EBIT, we apply a 40% tax rate to get $12m in NOPAT. This is calculated by multiplying $20m by 0.6 (1 - 0.4 tax rate).

Next, we add back the $5m in D&A to get $17m, then subtract $5m in capex and $2m in the change in NWC – for an FCFF of $10m.

For more insights, see: Nopat vs Ebit

EBITDA is a pre-tax and pre-interest metric that helps us understand a company's profitability before debt-related payments kick in. It's calculated by adding back the relevant non-cash expenses, like Depreciation & Amortization (D&A), to net income.

To get to EBITDA, we add back D&A to net income, which is a post-tax and interest metric. This is similar to calculating the cash flow from operations (CFO) section of the cash flow statement.

EBITDA is a useful metric because it gives us a clear picture of a company's ability to generate cash from its core operations. By removing the impact of non-cash expenses and interest payments, we can see how much cash is available to both creditors and equity holders.

To make EBITDA a more accurate representation of a company's financial health, we need to remove the tax shield associated with interest. This is done by adding back the interest expense amount, adjusted for the fact that interest is tax-deductible.

Check this out: Difference between Free Cash Flow and Net Income

Computing FCFE from EBIT or EBITDA can be done using the expression for FCFF from EBIT or EBITDA, and then subtracting after-tax interest and adding net borrowing.

To obtain FCFE based on EBIT, use the expression for FCFF from EBIT, which is FCFF = EBIT(1-Tax Rate) + Depreciation - Fixed Capital Investments - Working Capital Investments.

FCFE can also be calculated from EBITDA, using the expression for FCFF from EBITDA, which is FCFF = EBITDA(1-Tax Rate) - Interest(1-Tax Rate) + Depreciation(Tax Rate) - Fixed Capital Investments - Working Capital Investments.

FCFE can be calculated from FCFF as FCFE = FCFF - Interest(1-Tax Rate) + Net Borrowing.

FCFE can be calculated directly from EBIT by using the expression FCFE = EBIT(1-Tax Rate) - Interest(1-Tax Rate) + Depreciation - Fixed Capital Investment - Working Capital Investments + Net Borrowing.

FCFE can also be calculated directly from EBITDA by using the expression FCFE = EBITDA(1-Tax rate) - Interest(1-Tax Rate) + Depreciation(Tax Rate) - Fixed Capital Investments - Working Capital Investments + Net Borrowing.

On a similar theme: Net Income to Free Cash Flow

EBITDA is not always accurate, and one reason is that it ignores interest and taxes, which can be huge and are reflected in Cash Flow from Operations.

Interest and taxes are both significant expenses that can greatly impact a company's bottom line.

Ignoring these expenses makes EBITDA a less reliable indicator of a company's ability to repay debt principal.

A company's Change in Working Capital can also be very significant and is reflected in Cash Flow from Operations, which EBITDA ignores.

Here are some key differences between EBITDA and Cash Flow from Operations:

CapEx is another item that both EBITDA and Cash Flow from Operations ignore, making both metrics less reliable indicators of a company's discretionary cash flow.

When calculating FCF from EBITDA, you need to subtract D&A to get to EBIT, which is $20m in this example.

The tax rate is then applied to EBIT to get NOPAT, which is 40% of $20m or $12m.

Related reading: Ebit vs Nopat

To calculate NOPAT, you apply a tax rate to EBIT, which is 40% in this case.

From NOPAT, you add back D&A, which is $5m, to get the pre-capex and pre-NWC number.

The $5m in D&A is added back to the $12m in NOPAT to get $17m.

You then subtract capex and the change in NWC to get FCFF, which is $10m in this example.

The final step in calculating FCFF is to subtract capex and the change in NWC, which are $5m and $2m respectively.

Check this out: Fcff