Free cash flow to firm (FCFF): definition and formula

Free Cash Flow to Firm (FCFF) is the cash flow generated by a company's operations and available to all capital providers, shareholders and lenders alike, before any debt service. The FCFF formula reads: FCFF = EBIT × (1 - tax rate) + Depreciation and amortisation - Capex - Increase in working capital. It is the reference cash flow of the DCF method: projected FCFF is discounted at the WACC to obtain the enterprise value directly. Consistency is essential: FCFF must be discounted at the WACC, never at the cost of equity, and the tax rate applied to EBIT should match the jurisdictional profile of the business. FCFF is preferred over FCFE when the capital structure is expected to change over the plan, and net financial debt is deducted from enterprise value to reach equity value.

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FCFF vs FCFE: FCFF is measured before debt service and discounted at the WACC to give enterprise value, while FCFE (free cash flow to equity) is measured after after-tax interest and debt movements and discounted at the cost of equity to give equity value. The bridge between the two is: FCFE = FCFF - Interest expense × (1 - tax rate) + Net borrowing. Pairing the wrong flow with the wrong rate is a classic DCF error. Building a reliable FCFF also requires normalising maintenance versus growth capex, recurring working capital swings and the effective tax rate applied to operating profit, three assumptions systematically challenged in due diligence and fairness opinions.

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Worked example: a Swiss industrial SME posts EBIT of CHF 2.4 million, a 14% tax rate, depreciation of CHF 0.6 million, capex of CHF 0.8 million and a working capital increase of CHF 0.2 million. FCFF = 2.4 × (1 - 0.14) + 0.6 - 0.8 - 0.2 = CHF 1.66 million. Valued as a growing perpetuity at a 9.0% WACC with 2.0% terminal growth, the enterprise value is 1.66 × 1.02 / (0.09 - 0.02) = CHF 24.2 million, from which net financial debt is deducted to reach equity value.

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Hectelion builds FCFF-based DCF models with rigorous normalisation of capex and working capital assumptions, documented to withstand counterparty and auditor scrutiny.